After commencing its rate hiking cycle at the May meeting, the RBA Board is set to hike rates again today (decision due at 2:30PM AEST). My expectation is that the Board will hike its key rates by 40bps, increasing the cash rate target to 0.75% and the rate on Exchange Settlement balances to 0.65%.
The process of withdrawing the emergency support the RBA delivered to the Australian economy during the pandemic has been a long and gradual one that started around 12 months ago. This has seen the Term Funding Facility wound down, the 3-year yield target being discontinued and QE purchases ending. The next step was taken in May with the decision to hike the cash rate target off its pandemic low of 0.1%, a move characterised by the RBA as the start of "normalising monetary conditions".
With updated forecasts revising the core inflation outlook materially higher to remain above the 2-3% target band until mid-2024, the most significant observation from the RBA coming out of the May meeting was the role domestic capacity constraints were playing in adding to price pressures coming from global factors. The domestic aspect is what monetary policy is being used to address. Although settling for a 25bps hike in May, the meeting minutes later revealed that a larger hike of 40bps hike had come under consideration.
Since the May meeting, last week's national accounts underscored the resilience of the economy, with output rising by 0.8% in a heavily disrupted March quarter, driving the post-Covid expansion in GDP to 4.5%. Reflecting the tightness in the labour market with the unemployment rate at its lowest level since 1974 at 3.9%, the national accounts also reported labour costs were picking up, indicating aggregate wages growth is likely to rise further in the quarters ahead.
In what shapes as a finely balanced decision, markets and analysts are split on whether the Board will hike by 25bps or 40bps today. My expectation is the Board will side with 40bps, with the move to frontload the hiking cycle being consistent with its messaging around "normalising monetary conditions" by returning the policy rate to its pre-pandemic level of 0.75%. However, more important than today's decision is how the RBA sees the trajectory for rates evolving over the back half of the year, with markets to key off any comments in this respect in today's statement from Governor Lowe. The technical assumption used by the RBA in its forecasts has the cash rate rising to 1.75% by the end of the year, leaving daylight to a more aggressive profile being priced by markets.
