Governor’s statement slightly more hawkish than in December. We confirm our forecast for the cash rate to peak at 3.85% in May.
The Reserve Bank Board decided to increase the cash rate from 3.10% to 3.35% at its February meeting. That decision was in line with market expectations and the Westpac view.
The major area of uncertainty around the decision was in the wording of forward guidance. Westpac expected that this would be in line with the wording in the December Statement: “The Board expects to increase interest rates further over the period ahead, but is not on a pre-set course”.
There was considerable speculation that this wording would be ‘diluted’, perhaps shifting to something along the lines of: “The Board is prepared to increase interest rates further …”. Such a change would have implied a possible pause at the March meeting.
In the event the wording was arguably, slightly more hawkish than even Westpac expected, namely: “The Board expects that further increases in interest rates will be needed over the months ahead …”. The qualification used in December “not on a pre-set course” was excluded. While not definitive, the use of “not on a pre-set course” could be interpreted as indicating the possibility of a pause being considered in the next month.
By excluding that qualification it seems to be very clear that the Board anticipates increasing the cash rate by a further 0.25% in March.
That profile is consistent with the Westpac view that the cash rate will be increased on two further occasions in March and May, the last move coming in response to the March quarter inflation report.
Other aspects of the statement that can be interpreted as more hawkish than the December Statement.
Despite recognition that global inflation was moderating, reflecting supply-side adjustments, there was no downward adjustment in the Board’s forecast for inflation since the November Statement on Monetary Policy (SoMP). These remain unchanged at 4.75% for 2023 and 3% for mid-2025 (the latter compares to a 3.2% forecast by end-2024 back in November).
The growth and unemployment forecasts are also unchanged from the November SoMP. Growth is forecast to be around 1.5% in both 2023 and 2024 and the unemployment rate is still forecast to lift to 3.75% by end-2023 and 4.5% by mid-2025 (compared to 4.3% by end-2024 in the November SoMP).
One surprise on the real economy outlook was that the Governor states that: “The recovery in spending on services following the lifting of COVID restrictions has largely run its course”. This conclusion is not apparent in the data so far with the surprise collapse in retail spending in December relating to household goods; clothing; and department stores rather than any cooling in in services spend.
We also saw a surprise downgrading of the sentiment in previous statements around the lags in the system. Whereas a full paragraph was allocated to discussing these lags in December, only one sentence focussed on the lag issue in February, albeit still referring to “a painful squeeze” on households’ budgets.
The most likely explanation for the more hawkish statement is around inflation developments. Underlying inflation was noted at 6.9%, running “higher than expected.” But the concerns around high inflation becoming entrenched in “people’s expectations”; the damage from high inflation; and the clear priority “to return inflation to target” all signal that inflation is front and centre of the Board’s thinking.
Conclusion
Westpac remains comfortable with the view we expressed in October that the cash rate is likely to peak at 3.85%. That will entail a further 0.25% increase in March and a final 0.25% increase at the May Board meeting as the Board is able to respond to the March quarter inflation report.
