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BILL’S BITES: RBA surprise only delays cash rate peak

03:30pm October 05 2022

The Reserve Bank of Australia took the market by surprise in only raising the cash rate by 25 basis points at its October board meeting, when the majority of economists, including myself, had expected another 50 basis point increase.

Up until a couple of weeks ago, we had expected a 25bp move, but increased our forecast following a big surge in global interest rates associated with hawkish messaging from the US Federal Reserve. We felt that Australia's interest rates would have to move partly in line with that.

In going for a smaller increase, the RBA decided to take into account the rapid pace of tightening so far and to wait and see how the economy evolves under the weight of that.

The other factor was concern about the headwinds facing the world economy, which ran counter to our thinking that higher global rates argued for a bigger move. 

Even so, the RBA’s statement says that further increases are likely to be required. We still believe that the cash rate will peak at 3.6 per cent, but it will take a little longer to get there. 

We’re sticking with our view that we’ll see 25bp increases in November and December, and again in February when the RBA returns from its summer break. That will follow what is likely to be a very strong inflation report in late January.

The RBA appears confident that Australia can avoid a strong lift in wages growth, with its October statement noting that, while it had picked up, wages growth “remains lower than in other advanced economies where inflation is higher.”

We do not share the RBA’s confidence around the containment of wage pressures and expect that economic growth will have to slow to 1 per cent in 2023 to achieve an acceptable slowdown in inflation and wages growth.

In February, we’ll get a report showing wage inflation gaining momentum, which will mean the RBA will have to go for another 25bp move in March, taking the cash rate to that 3.6 percent terminal rate.

The market was shocked by the RBA move and that’s reflected in it paring back expectations for the peak rate to around 3.5 per cent, from more than 4 per cent previously, and I expect that’s where it will settle.

It could be a different story for the Australian dollar: with interest rates here not rising as far as those in the US, more downward pressure is imminent. We’ve still got the Aussie ending the year at around 65 US cents. 

For the full report, visit WestpacIQ

William (Bill) Evans is Westpac’s economic spokesman and is responsible for all of our economic research. In 1991, Bill joined Westpac as the Chief Economist and Head of Research. A graduate of Sydney University (BEc. Hons I and University Medal) and the London School of Economics (M. Sc.), Bill has worked as Research Manager for the Reserve Bank of Australia and as a Treasurer at the Commonwealth Bank of Australia. Bill travels frequently, advising Westpac’s customers on the Australian economy and financial markets.

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