The Board has rebalanced its focus towards inflation and inflationary expectations. We expect there is more near-term work to be done to emphasise this message with another hike now likely in July.
The Reserve Bank Board raised the cash rate by 0.25% to 4.1% at its June Board meeting.
The Governor’s statement has rearranged the order of previous statements to put maximum emphasis on the damage associated with high inflation and inflationary expectations becoming entrenched in the economy. He points out that services price inflation is still very high and that unit labour costs are rising briskly with productivity growth remaining subdued. He also points out that public sector wages are expected to pick up further and that the annual increase in award wages was higher than last year.
He clearly now sees his dominant objective as being to contain inflation expectations and achieve the inflation objective which he now sees as associated with more risk.
The statement acknowledges “a substantial slowing in household spending” and “uncertainties regarding the global economy” but the emphasis has clearly pivoted away from concerns around domestic growth and maintaining the progress that has been achieved around the labour market since the pandemic, and towards ensuring that inflation returns to target, reflecting the rising risks around wages growth and inflationary expectations. He further emphasises that: “The Board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages”.
Our reading of the statement is that the Board believes that further work will need to be done in the near term to allay their concerns around inflationary expectations and wages growth.
Despite having increased the cash rate in both May and June we expect that a further rate hike will be required by the Board in July, to really emphasise their commitment to the inflation objective.
Thereafter the risk is that a further follow-up move may be required at the August meeting when the June quarter inflation report will be available. We expect that underlying inflation will have dropped from 6.6% to 6.1% but labour markets will remain tight and the ongoing concerns around wage pressures will persist.
The additional risk for the August meeting is that, due to these concerns around expectations, the staff may raise their inflation forecasts which would open the door to another rate increase.
Westpac has been expecting the first rate cut in the next easing cycle to come in February 2024 with at least 100bps of cuts over the course of next year. Since that call was made, the Board has now raised the cash rate by an additional 50bps with another 25bp move now expected in in July.
While this will put additional pressure on the Australian economy, particularly for households and eventually business, progress on reducing inflation and wages growth will not be sufficient to allow for a pivot to rate cuts any earlier than February.
Our current forecast for growth in the Australian economy in 2023 is 1%yr. Since that forecast was issued we have seen a lift in wages growth for certain sectors; higher immigration and a recovery in house prices. But the revised rate profile is certain to weigh even more heavily.
We expect the Australian economy grew by a very tepid 0.3% in the March quarter and further weakness is now almost certain through the remainder of the year. We will review our growth profile to take these major developments into account following the release of the national accounts.
Conclusion
The Board has become increasingly concerned around inflation risks. It has now raised the cash rate on two consecutive months following the pause in April.
We now expect a follow up move in July with risks of a further increase in August.
