The RBA increases rates for the first time since Nov 2010

About the author:

Andrew Tang
Author name:
By Andrew Tang
Job title:
Analyst - Equity Strategy
Date posted:
03 May 2022, 4:35 PM
Sectors Covered:
Equity Strategy and Quant

Until now, the RBA remained an outlier among developed market Central Banks in maintaining its pandemic level settings. Last week’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 (March CPI 8.5% annual). So what prompted the RBA to move today? The Bank’s central forecast for inflation and unemployment has changed materially.

Under 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.

The RBA noted in today’s statement: “The economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than was expected. There is also evidence that wages growth is picking up. Given this, and the very low level of interest rates, it is appropriate to start the process of normalising monetary conditions…

The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead. The Board will continue to closely monitor the incoming information and evolving balance of risks as it determines the timing and extent of future interest rate increases.”

Today’s move marks the first of many rate rises expected over the next 12 months. Implied market expectations suggest the cash rate could end 2022 at 2.5% from the current level of 0.35%. Our forecast is under review but at this stage we expect the cash rate to reach 3% by the end of 2023.

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.

Banks

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.

Looking ahead

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.

For our full list of Best Ideas, including our mid-cap and small-cap key stock picks, download our full research note (Morgans clients only):

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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