As expected the Reserve Bank raised the cash rate by another 25 basis points last week – the eighth consecutive hike and a total increase in interest rates of three percentage points.
This brings the cash rate to 3.10%, which is its highest level since November 2012.
Clearly the board remains committed to overcoming the challenge of high inflation which has remained a concern throughout the past year.
As such, it has continued to increase rates, while also monitoring domestic economic conditions and global risks.
The statement from RBA governor Philip Lowe that came with the latest rate hike highlighted that the board “remains resolute in its determination to return inflation to target and will do what is necessary to achieve that”, pointing to the likelihood of further increases given inflation remains elevated.
The statement also highlighted tight labour market conditions and the “evolution of labour costs” with the RBA concerned about wage-price dynamics.
"Wages growth accelerated in the September quarter and rose by 3.1% in the previous 12 months.
The quarterly rise, the strongest acceleration in more than a decade, shows labour market tightness is now translating to stronger wage rises.
However, the current level of wage growth is still relatively restrained when compared with other developed economies and is not likely to endanger a wage-price spiral.
It sits comfortably at the lower end of the RBA’s desired 3% to 4% annual pace indicating sustainable, demand-driven inflation, after a decade of stagnation.
In addition, Australia likely sits on the cusp of an increase in labour supply, with migration rebounding strongly. With economic growth slowing into 2023, wage gains are not likely to strengthen substantially further."
During the week, the Australian Bureau of Statistics’ new monthly Consumer Price Index inflation read came in weaker than expected, falling from 7.3% year-on-year in September to 6.9% in the 12 months to October.
Although, the different expenditure weights applied to the standard CPI basket of goods and services in the monthly release mean that the outcome comes with caveats.
Ms Creagh said:
"At any rate, inflation remains well above the RBA’s 2% to 3% target band, and while the RBA is forecasting inflation to peak in the December quarter of this year, their expectation is for inflation to sit above that target band until the end of 2024."
While some commentators believe this latest RBA interest rate increase might well be the last for some time, others expect one or two further rate increases in early 2023.
But, as it happens, the bank won't increase rates again for at least a further two months.
The board doesn’t meet in January, meaning the nine weeks between now and its first meeting for 2023 on February 7 will provide an unusually long time for reflection – the first after eight relentless months of hikes.
From time to time, Reserve Bank officials talk about the idea of a “pause”.
Interest rates have increased substantially this year and we are likely to see further tightening in the first quarter of 2023.
However Ms Creagh commented:
"There is likely to be a further 25 basis point rise in February, although this may be followed by a pause as the RBA assesses the impacts of rising rates on households and the economy.
It takes time for higher rates to fully impact household cash flows and spending intentions, particularly with so many home borrowers have taken advantage of record low fixed rate mortgages throughout Covid."
Of course, last week's statement from Mr Lowe reiterated this concern, noting household spending "is expected to slow over the period ahead".
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In fact, the substantial tightening already pushed through this year is likely to weigh on consumption and GDP growth ahead.
As such, the RBA will likely allow time to assess the impact of the substantial tightening that will have been pushed through given the lagged impact of monetary tightening and the ongoing risk of a global recession.
Although the annual inflation figure for the year to December due on January 25 is expected to be high – the bank is expecting 8% – the quarter-to-quarter result is likely to show inflation weakening.
The ABS the quarterly inflation figures only come out once every three months.
But for some time now it has also been calculating inflation monthly, using a smaller survey that seems to give a pretty good indication of what the larger survey is about to show.
The chart below shows what the smaller survey has been saying each month about inflation over the previous three months alongside what the larger quarterly survey has been saying.
The two line up, except that in recent months the monthly measure has been sliding.
Source: The Conversation
This suggests that the official quarterly figure released in January will be weak.
At the same time overseas inflation, particularly in the USA, is weakening.
As Ms Creagh explained:
"As spending slows and economic conditions moderate, the RBA is likely to find it appropriate to pause their tightening cycle and further assess the impact, given the “narrow path” that lies between taming inflation and keeping the economy on an “even keel”.
The fast rise of the cash rate now exceeds the 1994 tightening cycle and has quickly rebalanced the housing market from last year’s extreme growth levels, with prices falling in most parts of the country."
Meanwhile, prices nationally are now sitting 3.81% below their March peak, slipping for the eighth month.
In Sydney, prices are down more than 6% from peak and below levels recorded in November last year.
Obviously, with additional rate rises on the horizon, borrowing costs will continue to increase and maximum borrowing capacities will be further reduced, shrinking buyers’ budgets.
Ms Creagh further explained:
"Now that the cash rate is sitting at 3.10%, maximum borrowing capacities have shrunk by close to 30%.
The significant reduction implies further price falls.
But if interest rates peak in 2023 as many expect, price falls are likely to ease, with values stabilising as interest rate uncertainty reduces."
Source of charts and commentary: REA Insights