The outlook for the future path of RBA cash rate policy is finely balanced.
Further rate increases are not completely off the table, but only if the inflation outlook changes materially from here.
Our core view is that CPI will continue to track lower and return to the RBA’s 2-3 per cent target band in 2025, a similar timeline to the central bank’s own expectations.
However, there are a number of broader risks to the economy and inflation outlook that we’re keeping a close eye on.
1. The housing market
Housing prices are back close to the peaks we saw pre-pandemic. That’s not what you would have expected given the rise in interest rates and weak income growth.
Population growth is a large part of the story and it’s telling that the countries which have seen the biggest surges in population are also the ones where housing prices have picked up most noticeably.
This matters because positive wealth effects can boost household spending and add some upside risk to domestic demand and so inflation. The RBA has called this out in their minutes.
We allow for these effects in our forecasts, but the more this goes on, the more forecasts will have to be scaled up – and the more likely it becomes enough to tip the RBA Board’s hand.
2. Rising long bond yields
The second risk is a global one and relates to the inflation situation we have already gone through. So far, medium term inflation expectations have remained anchored, as they need to, while short-term expectations have followed actual inflation down – no dislodgement of anchored expectations here.
But bond yields globally are higher. There are a few things going on here, most of which seem to relate to fiscal policy. If global fiscal policy turns out to be more expansionary than in the post-GFC period, central banks will have to do more to mop up the extra demand. If that is the case, interest rates globally could be higher on average than they otherwise would be.
More broadly, the recent chaos in the U.S. Congress over budget spending has unsettled the market, while the conflict in the Middle East is another factor.
If inflation expectations dislodge, that will put further upward pressure on bond yields, although this risk is probably diminishing. There’s also risk that, even if expectations remain anchored, bond yields keep rising because of the fiscal and geopolitical risks.
3. China’s economy
China’s recovery from a prolonged period of COVID-related lockdowns was slower than expected.
Things are looking a bit better now, but the consumer is weak and it remains to be seen how much the troubles in the property development sector spill over to the rest of the economy. The Chinese authorities have introduced some stimulus measures but they have been small scale.
On top of the shorter-term recovery from COVID and macro policy related questions, there is a broader question about China’s trend growth from here.
It is no longer in the phase of fast catch up to the rest of the world and no longer the obvious destination for foreign investment into low-cost production. Its population is already ageing and shrinking and the policy environment is geared more to control than to growth.
The role of China as a locus of demand for Australian production makes this a particular risk for Australia. For example, iron ore is Australia’s biggest single export and a large share of that goes to China. China drives the market for iron ore because it produces more steel than the rest of the world put together.
As a result, it drives Australia’s terms of trade and has a large bearing on growth in national incomes.
So far, despite the problems in the construction sector, Chinese demand for steel has held up and so have iron ore prices, but it’s something we’ll be watching closely.