By David Rogers
The RBA’s August meeting is “live” but a rate hike would come as a surprise to many.
Despite higher-than-expected inflation data and increasingly hawkish rhetoric from the central bank, Morgan Stanley said its clients mostly disagreed with its rate hike prediction.
While rate hike pricing hit its highest level for the year last week, a restart of hikes remains broadly unexpected by financial markets and could have a significant impact.
Six financial markets economists — from Citi, Deutsche, Judo Bank, Morgan Stanley, Rabobank and UBS — expect the RBA to hike its cash rate target by 25 basis points to 4.6 per cent at the August meeting.
But, most think the RBA will stay on hold before starting to cut rates in the March quarter.
The money market sees the chances of an August rate hike sitting at roughly 40 per cent.
Wilson Asset Management portfolio manager John Ayoub isn’t ruling out a rate hike, but says it’s unlikely to come as soon as August.
“The last two data points could suggest we are more likely to see a rate hike, but they are partial data on the economy, so it gives them an excuse to wait and see if the data holds up,” he said.
“Certainly if we see the data remain strong in June and into July then they’ve got no excuse and they will have to … although we’ve thought rates would be on hold until early next year, it’s becoming increasingly difficult to ignore what we’re seeing.”
After a higher-than-expected monthly CPI indicator for May last week, May retail sales rose 0.6 per cent in seasonally adjusted terms versus the 0.3 per cent expected by economists.
However, the ABS said retail sales were “boosted” by early end-of-financial year sales.
“June could be softer, but we start to see tax cuts come through in July,” Mr Ayoub said. “Does that lead to another pop in retail sales?”
In his view the path to lowering inflation and preserving jobs is “getting narrower and narrower”.
Morgan Stanley disagrees with the pushback on its rate hike view.
Clients said the RBA is a “reluctant hiker”, and the bar to restart rate hikes is “too high”.
“It is true that the RBA has hiked rates cautiously over the past few years, relative to most other central banks,” said Morgan Stanley Australia economist Chris Read.
The RBA has rationalised this choice as allowing for a slower decline in inflation, back to target, in order to preserve as many jobs as possible and avoid a recession.
However, the RBA also emphasised its data dependence and its communication turned increasingly hawkish over recent months as the inflation trajectory has moved away from its forecasts.
“While the RBA has shown a clear preference to not accelerate the downward path of inflation with tighter policy, the stalling of progress over 2024 is much more consequential and is likely to raise concerns around broader inflation expectations,” Mr Read said.
In its June meeting minutes the RBA said information since its previous meeting “reinforced the need to be vigilant to upside risks to inflation”.
“Raising the cash rate at this meeting could be appropriate if members formed the view that policy settings were not sufficiently restrictive,” the RBA added.
Mr Read said this communication “sets up August as a live meeting”.
“In many ways, the set-up is similar to the November meeting last year, where the RBA had been on hold for five months before ultimately hiking rates on the back of a strong quarterly inflation number,” he added.
A second area of pushback was regarding the fact the economy is showing clearer signs of weakening.
But, the weakness in discretionary spending isn’t enough to contain broader inflation pressures as the labour market is tight and loosening only gradually and significant fiscal stimulus will slow underlying disinflation progress further.
Investors also said the consensus for June quarter inflation of 4 per cent on-year was only slightly above the RBA’s forecast of 3.8 per cent.
But, it will be “the key catalyst” for the RBA to hike in August and therefore “meaningful in the context of the direction of travel so far this year”, according to Morgan Stanley.
“While this is only 20 basis points above the RBA’s May forecast, this was already revised up from 3.6 per cent in February and would represent six months of no core disinflation progress,” Mr Read said.
A fourth argument against a hike was the RBA won’t do so while other central banks are cutting.
However, history disagrees, with several periods of divergence, most recently through 2015-18 where a tighter starting point saw the RBA cutting rates and not following hikes by other central banks.
“At the current juncture, while cuts from other central banks are incrementally helpful, RBA policy is still less restrictive than most, compared to both current inflation and estimated neutral rates, particularly given a more positive fiscal impulse over fiscal 2025,” said Mr Read.
Finally, clients said a single RBA hike would have no impact, but while it won’t dramatically change monetary conditions, Morgan Stanley thinks it will have a “powerful impact on animal spirits”.
“Consumer and business sentiment has been firmly focused on ultimate easing of policy — a reversal of direction will alter near-term behaviour, dampening the stimulatory impact of fiscal policy that kicks in over the next six months,” he added.
