The next move in the RBA cash rate likely remains down later this year

Key takeaways

While the near-term risks for the RBA cash rate are probably on the upside, the most likely scenario is that the RBA holds rates ahead of rate cuts starting later this year.

The March quarter US and Australian inflation scare is likely receding, Australian economic growth is very weak, the labour market is cooling & the effective rise in interest rates in Australia has been more than in comparable countries.

It’s now two years since the RBA first started to raise interest rates resulting in the biggest tightening cycle since the late 1980s.

Rates have gone much higher and stayed high for much longer than I thought would be the case as Australian households proved more resilient than expected thanks to a combination of a boost to demand from reopening after COVID, saving buffers, a greater proportion of borrowers on fixed rates and the strongest population growth rate since the early 1950s.

So where to now?

The rollercoaster ride in interest rate expectations

This year has seen a bit of a rollercoaster ride in interest rate expectations – which may be what you would expect at a turning point in the cycle.

Early in the year, the money markets had priced in nearly three RBA 0.25% cash rate cuts for this year, with around seven Fed rate cuts.

After the March quarter inflation scares in Australia and the US, the money market in the US had scaled back to just 1.5 cuts and the local money market started to price in rate hikes.

The last two weeks have seen money markets become dovish again with two cuts priced in by year-end for the US and one partly priced in for Australia.

The renewed dovishness reflects better April inflation in the US, a less hawkish than feared Fed, a less hawkish than feared RBA, the Budget being seen as neutral, and softer data for local wages and jobs.

The minutes from the last RBA meeting confirmed it considered another hike and didn’t consider a cut and it warned that “the risks around inflation had risen”.

This suggests the RBA retains a tightening bias. However, its guidance that it’s difficult “to rule in or out future changes in the cash rate” along with its unchanged forecasts for inflation to fall into the target range next year suggest the tightening bias is mild.

The case for another rate hike

The main arguments for further rate hikes are that:

• services inflation and trimmed mean inflation (a measure of underlying inflation) remained sticky at 4.3% yoy & 4% yoy in the March quarter;
• wages growth could have another leg up, keeping services inflation high as the labour market remains tight with risks flowing from strong increases in wages for aged care and childcare workers & if the coming Fair Work Commission (FWC) decision for awards comes in high;
• The budget provided additional stimulus to the economy on top of the Stage 3 tax cuts from July; and finally
• the RBA cash rate is below that in comparable countries - with the ECB at 4.5%, Canada 5%, UK at 5.25%, US at 5.25-5.5% and NZ at 5.5%.

The case for rate cuts later this year

However, while the risks at the next few RBA meetings are still on the upside for rates, the RBA’s hurdle for another hike looks to be high requiring future data to threaten its forecasts for inflation to return to target in 2025 and 2026.

We see the most likely outcome as being the RBA holding at current levels, ahead of rate cuts later this year.

First, the economy has slowed to a crawl and likely remains in a per capita recession.

Real retail sales fell again in the March quarter & are down 5 of the last 6 quarters with per capita retail sales down 7 consecutive quarters.

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