RBA takes another breather

The Reserve Bank of Australia (RBA) kept the cash rate at 4.1% for the second month in a row. Similar to last month, the RBA would like more time to observe the economy’s response to the rapid rise in interest rates that occurred over the last eighteen months. Since the July meeting, there have been positive developments for the RBA. Inflation has come in softer than expected, and there are signs that the rate hikes are slowing consumer spending. We believe we might be near the end of the hiking cycle, but a resurgence in consumer spending could bring another hike back on the table.

Inflation was softer than expected in June quarter

Inflation is steadily declining and was below the RBA’s expectations in the June quarter. While certain areas of the consumer basket (like rents) show strong inflation, the overall level of above 6% is still too high. However, the effects of monetary policy are still being felt and it is expected to further reduce the inflation rate. The RBA has maintained its inflation forecasts and expect a return to their 2-3 percent target by the end of 2025.

Source: Refinitiv Datastream, Russell Investments, 1 August 2023

Consumers are feeling the pinch

Consumer spending has slowed further, barely showing any growth on a per-capita basis. Retail sales declined in June, partly due to an uplift in clothing purchases influenced by unseasonably cold weather in May. Additionally, higher interest rates have affected disposable incomes. Earnings season for Australian companies is about to ramp up, we will be looking for commentary from consumer-facing companies on the outlook.

Source: Refinitiv Datastream, Russell Investments, 1 August 2023

Unemployment rate will begin to rise

The labour market remains the one bright spot, consistently surpassing expectations. The unemployment rate remains at very low levels, and the employment-to-population ratio is very elevated. However, the labour market is a lagging indicator and the forward indicators for labour demand have continued to moderate.

House prices are rising, but not a big concern

House prices have continued to increase in recent months. This was a factor that influenced the RBA’s decision when it surprised the market with a rate hike in May. The RBA noted that some households benefit from rising house prices, but it’s not enough to offset the pain felt by others. At this stage, rising house prices is not enough to warrant further interest rate increases.

Consumer and labour market are key to future decisions

So, what would lead the RBA to hike rates again?

The hurdle for future hikes seems to have increased due to the RBA’s inaction. However, two developments could lead the RBA to raise rates again. The first is an increase in consumer spending, which the RBA has been concerned about. The second is a rise in wages without a corresponding rise in productivity.

Taking a step back, we believe the Australian economy will likely achieve a ‘soft landing’ in avoiding a recession. Growth may slow further, but the savings buffer of many households and strong immigration will provide some support.