The RBA has decided to hike

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Will November be the last?

So, the RBA has decided we need another rate hike. Deputy Governor Hauser told us so last week and Governor Bullock told Parliament this week – so much for “no forward guidance”. Why did the RBA have to signal a rate hike was imminent ahead of its Cup Day policy meeting next week? Because the market had mis-read the RBA following its September meeting. Whose fault was that? The market’s or the RBA’s?

Inflation is still too high 

Let’s leave the finger pointing aside and look at the current situation and where we go from here. The reality is inflation remains too high at a 3.6% underlying rate, with little hope that rate will fall for at least six months. And the headline rate for the month of September, which affects the purchasing power of household income, is 4.3% up from 4.0% in August. The differential between the underlying rate and the headline rate is substantial reflecting higher prices of transport (i.e., oil and the ending of the excise tax cut to petrol) and housing.

These high-baller prices are “trimmed” from the underlying rate as they are assumed to be “transitory”. Therefore, central banks tend to “look through” the influence of such price movements to avoid raising interest rates only to find prices fall back to more normal rates. But many households and businesses don’t have the luxury to “look through” high and rising prices. Of course, many households and businesses will also struggle with high and rising interest rates.

The RBA faces an uncomfortable choice

And so, the RBA finds itself on the horns of a dilemma. Should they wait and see if the current elevated rate of inflation proves temporary, as it had hoped following the brief hiatus in the Iran conflict, or will it strike now knowing that it is driving the economy closer to recession. The RBA has given its clear answer over the last week-and-a-half – strike now. Will it have jumped too soon?

With Brent Crude breaking through US$110/bbl with little hope of much of a retracement this year, inflation pressure remains elevated across the global economy. This will be felt in Australia through imports and will add to domestic costs as the higher oil prices pass through domestic supply chains. As we pointed out in our Brief of the 2nd of October (What will the RBA do?), there will be a risk of further rate hikes if oil price remains above US$100/bbl. We were hoping we could hold out until the year end. But we were wrong and the risk has arrived now.

Compounding the problem facing the RBA is that Inflation over the year to September has been broad based. Inflation of both aggregate goods and aggregate services are above 4%, as are tradeables (goods and services exposed to international trade) and non-tradeables (goods and services most influenced by domestic factors). However, buried in the monthly data there are faint glimmers of hope. As our Senior Economist, Lynda Bourke, points out, “Inflation moderated…across several interest sensitive parts of the economy including housing, furnishings and clothing & footwear”. As Lynda concludes, tighter monetary policy “…appears to be doing its job”. At least in sectors mainly associated with the current housing market downturn.

November may not be the end of it

However, notwithstanding the rate rises to date, consumer spending has been holding up and data centre capex is adding to demand pressures in the economy. The question now for the RBA is “how high do we need to take rates to break the back of demand and kill off inflation?” In the absence of a sign that oil prices are ready to retrace, at least to US$100/bbl, the signs are that it will need to go higher than “done-and-dusted” in November. The risk, with growth already solidly below trend, is that the RBA pushes us into recession