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AUD Rate Outlook Uncertain as Inflation Rises

by Onuraag Das   ·  June 5, 2023  

AUD Rate Outlook Uncertain as Inflation Rises

by Onuraag Das   ·  June 5, 2023  

With economists and money markets at odds, the direction of AUD rate outlook remains uncertain. Lingering price pressures and a rebound in home prices have created a challenging landscape, making the decision on whether to hike or pause rates a difficult one.

According to a Bloomberg survey of 30 analysts, one-third of economists expect the RBA to raise its cash rate to 4.1% on Tuesday, including renowned institutions like Goldman Sachs Group Inc. and Royal Bank of Canada. However, the majority, including Commonwealth Bank of Australia, anticipate a hold at 3.85%. This divergence in opinions has created uncertainty, with traders pricing about 50-50 odds.

Divided opinions among economists and money markets on whether the Reserve Bank of Australia will hike or pause

CBA’s Head of Australia Economics, Gareth Aird, believes the upcoming meeting is now live and assigns a 70% chance of a hold, while acknowledging the tightening risk. Aird emphasizes that the domestic economy is showing sufficient signs of slowing, warranting caution in the RBA’s decision-making process.

The RBA’s meeting coincides with the Bank of Canada, another economy where policymakers are also contemplating a rate rise. Moreover, it precedes the Federal Reserve’s meeting, where a pause in the aggressive tightening cycle is expected. If Australia were to increase rates, it would stand out among its Asia-Pacific peers, with New Zealand signaling that its rate has peaked, while Korea and India have opted to keep rates unchanged.

Governor Philip Lowe has surprised RBA-watchers in the past by unexpectedly hiking rates following a pause. In recent weeks, his rhetoric has turned increasingly hawkish due to concerns about mounting inflation and labor cost risks. Lowe has been clear that the board will take whatever measures necessary to bring consumer price gains back down to the RBA’s target of 2-3%.

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The governor’s tough stance coincided with data showing higher-than-expected consumer-price growth in April. Additionally, the national minimum wage was raised by 5.75%, prompting several banks to predict a June rate hike. Deutsche Bank AG and Nomura Holdings Inc. even adjusted their terminal rate forecasts higher.

Economists highlighting the need for a rate increase worry that higher inflation expectations could become entrenched if not addressed urgently, considering recent global experiences. Furthermore, a resurgent housing market and soaring rents pose a threat to inflationary pressures.

However, the RBA’s own forecasts indicate that inflation will only return to the top of its target range by mid-2025. Governor Lowe will have an opportunity to explain his decision and provide an assessment of the economy in a speech following the meeting. Many economists expect him to signal further hikes ahead, even if he decides to pause on Tuesday, due to the expectation of higher and prolonged inflation.

Conclusion

The looming expiry of a large number of home loans fixed at record-low rates during the pandemic is another concern. RBA research shows that around 90% of fixed mortgages rolling off this year will see repayments increase by 30% or more. This raises cautionary flags, considering Australian households are among the most leveraged in the developed world.

With a debt-to-income ratio of almost 188%, the RBA must tread carefully to avoid pushing debt servicing costs to record levels as a share of household income. AMP Capital Markets predicts a June hike, highlighting the potential consequences of a cash rate exceeding 4%.

As the RBA convenes, all eyes are on the decision that will shape Australia’s rate outlook. The outcome will depend on balancing the need to curb inflation against the risks posed by a slowing economy and rising unemployment. The verdict will have significant implications for households, businesses, and the broader economic landscape in the months ahead.

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