By James Thomson

Money markets and a growing number of economists believe the RBA’s rate hiking cycle is done – even with inflation uncomfortable high and real rates deeply negative.

Just over 30 years ago, back when Barrenjoey was just a suburb near Palm Beach, the broking house that veteran investor Geoff Wilson was working for at the time invited then Reserve Bank of Australia governor Bernie Fraser to lunch.

Inflation was running at about 6 per cent at the time, but Fraser asked the assembled brokers to write down what they thought the actual rate of inflation was. All the estimates came in higher than the official number.

“Bernie spent the rest of the lunch trying to convince us we were wrong,” Wilson recalled on Wednesday at a panel for Future Generation, which operates two philanthropy-focused listed investment companies.

Wilson doesn’t believe inflation expectations are unanchored today, as Fraser feared they were back then. And Wednesday’s consumer price index, which showed the headline rate of annual inflation fell from 7.8 per cent in the December quarter to 7 per cent in the March quarter, with the all important trimmed-mean measure slowing from 6.9 per cent to 6.6 per cent, supports this view.

But Wilson points out that a generation of Australians is learning to live with inflation for the first time, and that it will take some time before inflation is anywhere near the RBA’s target of 2 per cent to 3 per cent.

Money markets suggest that the inflation data – and particularly the slightly lower than expected number for the trimmed mean – have given the RBA the excuse it was looking for to keep rates on hold, with the probability of a 0.25 percentage point rate rise next Tuesday dropping from 35 per cent at the start of the week to just 9 per cent.

Royal Bank of Canada chief economist Su-Lin Ong and Betashare’s David Bassanese went further, declaring governor Philip Lowe’s tightening cycle is now over.

“For an RBA that is reluctant to tighten much further and prepared to tolerate higher inflation to preserve the labour market gains, today’s data provide an excuse to stay on hold,” Ong said.

On the face of it, this would seem like an unlikely position for the central bank to adopt, given it was so stridently declaring just a few months ago that it would do whatever required to bring inflation back to target. While inflation has peaked, and the lagged way monetary policy works means the impact of the rate hikes already delivered are still flowing through, inflation remains uncomfortably high and real interest rates remain deeply negative.

Bassanese argues the RBA can take comfort in two factors. First, wage pressures remain far more muted than in other economies, and rising immigration should further help contain any wage outbreak. Second, the high level of variable mortgages in Australia means the transmission effect of higher official rates will be higher here than in other markets, with consumer spending already showing signs of weakening.

Ong also says the RBA is prepared to live with higher inflation. Yes, services inflation – particularly rents and utilities – remains more elevated than the RBA would like, and for those that see a further hike from the RBA either next week (such as Commonwealth Bank) or a few months from now (such as ANZ) it is services inflation that remains the key concern. But Ong argues a central bank that is dovish by nature will now want to see data that provides compelling reasons to tighten further.

As Chanticleer has previously argued, inflation challenges facing this RBA board and future ones are likely to remain tricky. Even as inflationary pressures from the pandemic fade, new pressures from defence spending, the rebuilding of supply chains and the energy transition will emerge.

The risk is that by accepting higher inflation now, the RBA faces a tougher job pushing the rate back down towards its target band down the track.

The prospect of what a higher level of inflation means for asset prices over the longer term is something investors should think through.

But for now, the headline news is that the peak in inflation is safely behind us, and the peak in interest rates is either here or very close.

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