Economic and Financial Market Update: Closer to the peak

Summary:

• As widely anticipated, the RBA raised the cash rate by 0.25% at its February meeting;
• High inflation was a key driver of the rate hike;
• The RBA made minimal changes to its economic forecasts;
• The Statement released following the meeting suggested that there are more rate hikes to come.

What happened at the February meeting

As expected, the RBA increased the cash rate by 0.25% at its February meeting (taking it to 3.35%). The reasoning was expected: the economy is doing OK, and inflation is too high partly driven by domestic demand.

The headline economic forecasts have not been changed significantly (a full update will be released with the February Monetary Policy Statement). Inflation is expected to be 4.75% by end 2023 and 3% by end-2024. GDP growth is forecast to be around 1.5% both this year and next. The unemployment rate is expected to expected to rise only a touch by the end of this year (to 3.75%) and to 4.5% by mid-2025. My forecasts are pretty close to those of the RBA for this year, although I think the economy might be weaker (and therefore the unemployment rate higher and inflation lower) by the end of next year.

The RBA changed its outlook paragraph from saying it ‘expects to increase interest rates further but is not on a pre-set course’ in December, to ‘expects further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target, and this period of high inflation is only temporary’ following its latest meeting. I take this as a signal that another rate rise next month is very likely, with a good chance of at least one more a month or two after.

The main reason for the change would have been that the underlying inflation measure in the December quarter was clearly higher than the RBA anticipated. They are concerned that if inflation stays too high for too long then it will become difficult for them to reduce it back to their 2-3% inflation target. If the RBA forecast of inflation of almost 5% and only a modest rise in the unemployment rate come true, there is little chance of a rate cut this year. Indeed, an inflation forecast of 3% by mid-2025 suggests minimal chance of a rate cut prior to 2025.

To read my full update, click here.

We live in interesting times.

Regards,

Peter Munckton - Chief Economist