For the first time in the RBA's hiking cycle, the Board considered the option to pause tightening at the December meeting. More tightening is likely in front of the RBA in 2023, but maybe not much more depending on the inflation outlook.
A recap of 2022...
2022 was an extraordinary year for the RBA. Many of the pandemic monetary policy settings remained in place at the start of the year, with rates sitting on the historic low of 0.1% and QE still running. The QE program was wound up in February, but it wasn't until May that the first rate hike came, a 25bps increase. Hiking was then frontloaded in 50bps increments for the four meetings from June to September. The downshift to 25bps hikes came in October (ahead of many other central banks) and was followed up with hikes in November and December. All told, rates were hiked by 300bps since May, taking the cash rate to 3.1%.
The path ahead...
All indications are that the RBA hasn't finished tightening yet. The Board's guidance that it "...expects to increase interest rates further over the period ahead" was retained in December and has essentially been unchanged over recent months. The one caveat to this is that it added back into the December decision statement the qualifier that rates are "...not on a pre-set course". A similar qualifier was used by the RBA earlier in the hiking cycle ahead of the October downshift. On this occasion, it may reflect the optionality the RBA wants to retain going into 2023. The December meeting minutes showed the Board considered 3 different options for policy earlier this month: hiking by 25 or 50bps, or for the first time since the hiking cycle commenced, going on pause.
The notion of pausing has bouyed local markets, coming on the back of last week's moves by the Fed, ECB and BoE to slow their respective hiking cycles (though all 3 remain hawkish) and in response to softer US inflation data. After initially drawing a firmly hawkish interpretation from the December meeting, markets have scaled back pricing for a 25bps RBA rate hike in February to a 50/50 proposition. Pricing for the terminal rate has remained well below 4%.
In addition to the rate hikes, the RBA's balance sheet will be playing a more active role in tightening monetary policy next year. The quantitative tightening (QT) process started in May alongside the first hike, with maturing bonds being allowed to roll off the balance sheet. But the profile of the RBA's bond holdings has meant the effect on the size of the balance sheet has been minimal so far, reducing only modestly from the pandemic peak to around $630bn currently.
The next couple of years will see the balance sheet reducing in size significantly. The main driver will be repayments of the cheap liquidity banks were able to access from the Term Funding Facility, with maturing bonds (acquired in support of the 3-year yield target and in the QE program) doing the rest. Because of this, the RBA has maintained the view bond sales are not required as part of QT. The chart below is from a speech by the RBA's Christopher Kent earlier in the year and shows the scale of the unwind that is ahead. Like most of its central bank peers, rates are the primary tool for the RBA, but the key point is that the balance sheet will contribute to a tighter monetary policy stance from next year.
Source: RBA
Inflation outlook holds the key...
The question going into 2023 then is when will the RBA press pause. While it appears likely that rates will be hiked when the RBA returns in February, that might just about see things out. Consistently the Board has referred to the delayed effects of rate hikes on the economy, and as discussed above the balance sheet will be a factor next year. It has also been mindful of the risks of overtightening, noting that it is attempting to return inflation to target "over time" while keeping the economy "on an even keel".
Before a pause can come, the Board will likely need to see the inflation outlook coming back into the 2-3% target band. Currently, the RBA sees inflation remaining above 3% out to 2024 despite expectations for a growth slowdown over the next couple of years. The RBA is cautious that upside risk to inflation could come from the labour market; however, wages growth only recently cleared 3%, a pace it has described as "not inconsistent" with the inflation target.
The RBA will update these forecasts in February. Deevlopments offshore over the summer could provide an indication of what to expect. A plausible scenario is that there is a further softening in the inflationary pulse and the effects of aggressive rate hikes start to weigh more on growth. If Australia follows suit, lower forecasts for inflation and growth could open the door to the RBA pausing its hiking cycle in March.
