RBA will hike by 40 bps in June: Westpac

On Thursday (21 April), the big four bank released its forecast for what it expects the Consumer Price Index (CPI) to be for the March quarter 2022. 

The official report, which measures the percentage change in the price of a basket of goods and services consumed by households – and is a fundamental data input for inflation – will be released by the Australian Bureau of Statistics (ABS) on Wednesday (27 April). The big four bank’s forecast for the upcoming CPI report forecasts that it will show rapidly rising inflation.

Indeed, Westpac expects underlying inflation in the quarter to rise from 0.9 per cent to 1.2 per cent, bringing annual underlying inflation for the March quarter at 3.4 per cent.

That represents an increase in the annual rate from 2.6 per cent in the December quarter and from 2.1 per cent in the September quarter.

The bank is also expecting to see a fall in the unemployment rate from 4 per cent to 3.8 per cent in April, a 48-year low (official unemployment figures would be published until 19 May).

When taking into account these two factors, the bank’s chief economist said this would likely result in the Reserve Bank of Australia (RBA) raising the official cash rate substantially in June 2022.

RBA ‘sensitive’ to large movements in underlying inflation: Bill Evans

Writing in an economic bulletin, Mr Evans explained that an increase in the annual rate of 0.8 ppts (percentage points) over one quarter and 1.3 ppts over two quarters is comparable only to 2007/08 – the genesis of the global financial crisis (GFC) – in recent times.

“In 2007, annual underlying inflation increased from 2.8 per cent in the June quarter and 2.9 per cent in the September quarter to 3.6 per cent in the December quarter (and 4.2 per cent in the March quarter),” he explained.

“Following the news on the December quarter inflation the RBA responded with 25 basis point rate hikes in both February and March 2008 bringing the rate to 7.25 per cent (significantly above neutral).

“That was despite it being quite clear to markets that the world was on the brink of a major financial crisis, (later in 2008 and early 2009 the RBA was obliged to cut the cash rate back to 3 per cent from 7.25 per cent).

“This episode just emphasises the sensitivity of the RBA to large movements in underlying inflation.”

While the major banks have all recently revised their cash rate forecasts, agreeing that they expect the RBA to start raising rates from June, the size of this hike is now being reconsidered.

Westpac had said earlier this month that it was expecting the first move to be 15 basis points to “restore the cash rate to 25 basis points”. This was based on the fact that the current (record-low) cash rate of 10 bps is unusual and the cash rate has been moving in 25 bps increments in recent years.

However, Mr Evans now expects the “rapid further increase in underlying inflation and a forecast fall in the unemployment rate for April, will result in the board of the central bank deciding to take “a bolder initial lift in the cash rate”, of 40 bps.

The major bank recently increased its one-year fixed-rate loans for owner-occupiers by 45 bps, to reflect.

Mr Evans concluded: “At the [3 May] meeting we expect the board will adopt a clear tightening bias in anticipation of a move in June. That should be sufficient to encourage the market to maintain its expectation that, despite steady policy in May, the cash rate will reach 40-50 basis points at the June meeting. 

“Our research shows that the RBA is influenced by market pricing near the time of a board meeting. If the market persists with a 40 basis point expectation it is unlikely that the board would persist with a 15 basis points move.”

The Westpac chief economist acknowledged that the RBA would be concerned about such a large move at the beginning of the cycle, particularly as it would impact confidence levels, and suggested that there was the possibility that the board could therefore take a more “cautious 25 basis point lift in June to be followed by the 40 basis point move in July”.

“However, we anticipate that market and media expectations will shift towards a 40 basis point move over the next six weeks and the anticipated shock to confidence will be contained,” he added.

Markets are currently priced for the cash rate to reach around 40-45 bps by the June meeting, however this is based on a 10-basis point hike in May and a further 30 points at the June meeting.

Both the Bank of Canada (13 April) and the Reserve Bank of New Zealand (13 April) have recently opted for 50-basis-point increases in their policy rates.

How the rate forecasts have been changing

Following on from the release of the Reserve Bank of Australia’s decision and statement on monetary policy on Tuesday (5 April), all four major bank economists have updated their predictions for when they expect the central bank to raise the official cash rate.

Last year, general market expectations were that the RBA would not raise rates until 2024 (as had been suggested by the central bank’s commentary, given economic forecasts at the time), however, rising inflation had seen forecasts start to shift earlier this year. 

In January, most economists were forecasting rates to rise in 2023, but these were torn up and reworked as domestic unemployment drops, wage growth stalls, and the global economy shifts as a result of COVID-19, the Ukraine-Russia conflict, rising tensions with Asian superpowers, and supply chain disruptions, among other factors.

By February, there was a marked difference between what the RBA was forecasting and what market economists were predicting when it came to the market conditions that would lead to an increase in the cash rate. The disparity was flagged during the House of Representatives standing committee on economics for its hearing on monetary policy in February, when the RBA defended its position.

In March, the war in Ukraine was causing a “major new source of uncertainty”, with market players speculating that Russia’s invasion of Ukraine could impact the central bank’s position on a rate hike. 

After the RBA released its cash rate decision earlier this month (for April 2022), all four major banks shifted their forecasts, all expecting a rise of 15 bps in June 2022. 

The revisions came following a change in the language used by RBA governor Philip Lowe in his monthly statement, whereby he removed the wording around the board being “patient”.

For example, in its March 2022 statement, the RBA noted it was going to be “patient as it monitors how the various factors affecting inflation in Australia evolve”.

However, the economists flagged that the April statement outlined that the board said it would instead assess additional evidence on both inflation and the evolution of labour costs (along with “other incoming information”) over the coming months.

[Related: Hit to home owners should curb rate hikes: AMP]