Equity Strategy: As expected the RBA increases interest rates by 50bps – cash rate up to 2.35%

About the author:

Author name:

By Andrew Tang

Job title:

Analyst - Equity Strategy

Date posted:

06 September 2022, 3:00 PM

Sectors Covered:

Equity Strategy and Quant

What we expected.

Given the ongoing strength in employment and consumer spending, the RBA has raised the cash rate a further 50bps to 2.35%, the highest level since February 2015.

Near-term inflation concerns continue to weigh on the RBA’s decision this month with the Bank sending another strong signal to the market that they are committed to the goal of restoring price stability.

The RBA has now put through the most aggressive series of interest rate rises since 1994 by raising rates 225bps over the past 5 months.

So what prompted another 50bps move this month?

According to today’s statement “Inflation in Australia is the highest it has been since the early 1990s and is expected to increase further over the months ahead. Global factors explain much of the increase in inflation, but domestic factors are also playing a role. There are widespread upward pressures on prices from strong demand, a tight labour market and capacity constraints in some sectors of the economy”.

The Bank’s central forecast for inflation and unemployment has changed materially since the start of the year. Inflation is expected to exit 2022 at 7.75% well above the 2-3% target range before settling a little above 4% in 2023. The Bank does not anticipate inflation to fall within its target range until 2025.

More to come?

In addition, Michael Knox in his 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 2.85% in October, and on current market pricing take the cash rate to over 3.5% by year-end.

The RBA is clearly making inflation their number one priority by moving rates in 50bps increments despite softening consumer confidence and slowing housing demand.

In July, Governor Lowe noted that “If people setting prices and wages were to believe that higher inflation will persist, they are more likely to push prices and wages up…. This is what happened in the 1970s and it ended badly… The RBA is committed to ensuring that the current period of higher inflation is only temporary and it will do what is necessary to bring inflation back to target. It will be harder to do this if the inflation psychology shifts.”

We think the strong commitment to curb inflation will leave the door open to further 50bps moves.

Outlook

Despite increasing recession risks and falling consumer and business sentiment, retail trade and labour data released last month were robust.

Retail trade beat expectations and is consistent with our view that Australian consumers still have elevated savings to run down (Australian Retail Sales – July 2022: Well dressed), which we expect to continue to support retail and travel sectors.

Similarly, the labour market appears resilient to the RBA’s efforts to curb demand. Job vacancies continue to rise with labour supply in some sectors unable to meet demand. The spike in vacancies also demonstrates increased labour mobility, suggesting that we are still far from an imminent economic slowdown.

Tighter financial conditions and stubborn inflation will create a different set of winners and losers from the past few years. We suggest investors review portfolio positioning to account for inflation that appears to be stickier than anticipated. Refer to our recent Reporting Season Review for our latest market views and ideas.

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