We now expect the RBA to delay its pause to October with a 25bp increase in September to follow on from our 50bp hike forecast for August. By moving the forecast rate hike in December forward to September we have not changed our terminal rate forecast of 2.6%.
We have reconfigured our RBA cash rate profile following the July employment report and some revisions to our inflation forecasts.
However, we have not lifted the forecast terminal rate of 2.6% by the February 2023 Board meeting.
We continue to expect a 50bp increase in the cash rate at the August 2 Board meeting.
But a pause in the cycle in September now seems unlikely.
We expect a 25bp increase in the cash rate at the September 6 Board meeting.
With our estimate of the neutral range of policy being 1.5-2.0% the September move of 25bps would shift the cash rate to 2.1%, into contractionary territory.
As we move further towards the end of 2022, we expect that the evidence that the RBA’s 200bp increase in just five months will start to impact the spending momentum.
Factors that we assess as important to maintaining spending momentum through the June and September quarters will have eased by October. These will include the ‘reopening’ effect in NSW and Victoria and the boost to spending capacity from the fall in the savings rate over the course of 2020.
To date our Westpac Card Tracker Index, based on consumption-related card transaction activity, has held up quite strongly but we expect that by late September spending momentum will have eased significantly.
Along with what are likely to be more very weak reads on Consumer Sentiment and Business Confidence; a sharp deterioration in housing markets; and evidence that the US economy is faltering under the weight of the high inflation and aggressive tightening from the FOMC, the case for a pause in October will be convincing.
We have slightly lifted our forecast for the June quarter inflation report.
Our forecast for underlying inflation (trimmed mean measure) has been lifted from 1.3%qtr to 1.4%qtr – largely reflecting a stronger increase in the cost of new dwelling construction, marked up from 4.6% to 5.5% in the quarter.
Our forecast for headline inflation in the quarter has also been lifted from 1.5% to 1.7%.
Overall, annual underlying inflation is expected to print 4.6%yr, up from 3.7%yr in March, and headline inflation is expected to lift from 5.1%yr to 6.1%yr (compared to our earlier forecast of 5.8%yr).
This slightly higher inflation is not sufficient to cause the RBA Board to lift the hike at the August meeting to 75bps but does increase the headwind for a pause in September, when the cash rate would be within the neutral zone.
The sharp fall in the June unemployment rate from 3.9% to 3.5% is more rapid but broadly consistent with our long-held forecast that the unemployment rate would reach 3.2% in the second half of 2022.
There is no need to lift the pace of the rate hike in August from 50bps to 75bps but the rapid improvement does weaken the case for a pause in September.
We did note that despite now factoring in a hike in September rather than a pause we still expect the peak in the cash rate to be 2.6%.
The rate hike we had previously expected in December has been moved ahead to September. That is consistent with our view that by December the evidence will be convincing that the Australian economy is slowing under the weight of a cash rate of 2.35% (following the expected 25 basis point move in November), which is firmly in contractionary territory.
We have also not changed the timing of the final rate hike in the cycle – a 25bp increase at the February 2 Board meeting.
We expect that the final move in the cycle will be in response to the March quarter inflation report that will show underlying inflation printing 1.0% for the quarter and a peak 5% annual rate, with headline inflation also expected to peak at 7.2%.
However, the key track of the underlying quarterly prints is expected to be: 1.4% (March); 1.4% (June); 1.2% (September); and 1.0% (December). That is a clear slowing in the quarterly pace but the annual rate is still too high for the RBA to pause. The mood of central banks to err in favour of containing inflation and expectations rather than fine tuning activity will be apparent in that decision.
That quarterly pause is expected to come at the May Board meeting when the quarterly pace in underlying inflation slows to 0.8% for 4.4%yr; down from 5%yr in the December quarter.
By May, the slowing Australian and US economies and the encouraging slowing in the quarterly inflation pace will be sufficient for the RBA to remain on hold, pending inflation and growth developments that could allow an eventual easing in policy.
By the second half of 2023 there will be some upward drift in the unemployment rate while underlying inflation will be converging on the top of the target band, although there will be caution around easing policy while inflation remains above the top of the 2-3% range.
