RBA lifts interest rates by 50bps – cash rate up to 0.85%
About the author:
- Author name:
- By Andrew Tang
- Job title:
- Analyst - Equity Strategy
- Date posted:
- 07 June 2022, 5:00 PM
- Sectors Covered:
- Equity Strategy and Quant
Last month’s CPI print cemented what the market had long been expecting, that the Australian economy is not immune from the global inflation forces (rising energy prices, global supply chain disruptions and labour shortages) sending the cost of goods and services higher.
While inflation pressures are building in Australia, they remain less acute (March Quarter CPI - 5.1%annual) than in the United States (April CPI 8.3% annual). So what prompted the RBA to move by 50bps today? The Bank’s central forecast for inflation and unemployment has changed materially.
Core inflation is now expected to exit 2022 at 4.75% well above the 2-3% target range and 2 percentage points higher than the Bank’s previous forecast. The Bank does not anticipate inflation to fall within its target range until 2024.
In addition, Michael Knox in his recent piece Watch the RBA copy the FED points to significant foreign currency distortions if the RBA were to leave interest rates disproportionate to the US Fed funds rate.
This means the RBA will likely move in 50bps increments consistent with upcoming Fed decisions. This will see the RBA increase the cash rate to 135 basis points in July, and on current market pricing take the cash rate to 260 basis points by year-end.
The RBA noted in today’s statement that:
“Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected. Global factors, including COVID-related disruptions to supply chains and the war in Ukraine, account for much of this increase in inflation. But domestic factors are playing a role too, with capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices.
The floods earlier this year have also affected some prices.
One source of uncertainty about the economic outlook is how household spending evolves, given the increasing pressure on Australian households' budgets from higher inflation. Interest rates are also increasing. Housing prices have declined in some markets over recent months but remain more than 25 per cent higher than prior to the pandemic, supporting household wealth and spending.
The household saving rate also remains higher than it was before the pandemic and many households have built up large financial buffers. While the central scenario is for strong household consumption growth this year, the Board will be paying close attention to these various influences on consumption as it assesses the appropriate setting of monetary policy..”
We think today’s move confirms the pivot in the RBA’s position on monetary policy, by moving rates ahead of market expectations the Bank is clearly prioritising price stability over employment and economic stability. We think the change in focus will leave to door open to further 50bps moves at upcoming policy meetings and thus no near-term respite for equity investors.
Elevated household savings and buoyant employment conditions will go some way to cushion the impact of higher interest rates but it is naïve to think that economy can get through the next period without any major hiccups. Monetary policy typically operates with a lag and therefore we expect to see higher rates result in a slower rate of consumer demand and economic growth in time.
Our Banks analyst noted recently (With the RBA set to dance, we take a cautious stance) that rising risks will not be a walk in the park for the banks nor the Australian economy.
- Although a rising official cash rate will benefit bank Net Interest Margins (NIM).
- Higher interest rates will likely place downward pressure on asset prices and credit growth.
- Higher interest rates will increase the risk of asset quality deterioration.
- Rising risk-free rates will place upward pressure on the cost of equity.
- From a dividend yield perspective, we expect downward pressure on valuations as we expect dividend yields to become less attractive relative to rising risk-free rates.
2022 will be a year where interest rates ratchet higher. Tighter financial conditions for households and companies will create a different set of winners and losers from the past two years. We suggest investors review portfolio positioning to account for inflation that appears to be stickier than anticipated.
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