Reserve Bank surprises with whopper rate hike, says brace for more
Analysts rush to revise forecasts upwards with many tipping rates just north of 2% by December.
The Reserve Bank of Australia surprised markets with the biggest cash rate increase in more than two decades on Tuesday and analysts say investors should expect more to come as the bank grapples with rising prices that continue to outpace the bank’s own forecasts.
The cash rate target will rise from 0.35% to 0.8% after the Reserve Bank raised rates by 0.5% for the first time since 2000 at its monthly board meeting on Tuesday afternoon. Of the 22 economists polled by Bloomberg prior to the decision, only three expected a move of this magnitude.
In a statement announcing the decision, Governor Philip Lowe cited inflation that is “higher than earlier expected” and blamed soaring prices on the lingering impacts of the pandemic, Russia’s war in Ukraine and a local economy straining at the seams.
However, the “resilient” local economy should power through higher rates, buoyed by flush savings accounts, high commodity prices and unemployment at fifty-year lows, he added.
“Today's increase in interest rates by the Board is a further step in the withdrawal of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic,” said Lowe. “The resilience of the economy and the higher inflation mean that this extraordinary support is no longer needed.”
Tuesday’s move vindicates the hawkish predictions made by traders in futures markets, who have long bet the Reserve Bank would be forced to walk back last year's guidance that rates would stay low until 2024. Futures markets correctly priced in Tuesday’s 0.5% rate hike and now expect a cash rate of 3.1% by December.
Commonwealth Bank economists dramatically revised interest rate forecasts upwards following the decision and now expect a cash rate of 2.1% by year end, compared to 1.35% before the meeting.
Peter Tulip, chief economist at the Centre for Independent Studies, previously of the Reserve Bank and Federal Reserve believes Tuesday’s outsized move is consistent with the predictions coming out of markets and suggests investors brace for the Reserve Bank to rapidly hike rates back into the 2%-3% range.
“There is still quite a bit to come and fairly soon,” says Tulip. “Once the cash rate starts to get up into the 2-3% territory you start inflicting serious discomfort on people. So, that’s when you want to be gradual. When there’s a lot of room to move, that’s when you want to move aggressively.”
Committing the bank to further interest rate rises in the months ahead, Lowe said the size and timing would be dictated by what happens with prices and the labour market. Fresh data on inflation and wages is due out in late-July and mid-August, respectively.
“The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead,” he said.
Commonwealth Bank, AMP Capital and Westpac are now tipping a second 0.5% rate hike in July, followed by a series of 0.25% rate hikes later in the year.
Equity markets were caught wrongfooted by the move, sinking 0.7% on the news and ending the day down 1.5%.
The Reserve Bank’s hawkish volte-face aligns it with central banks across the developed world, where officials are delivering meaty rate hikes in back-to-back sessions in a rush to normalise monetary policy after the pandemic.
New Zealand’s cash rate hit 2% in May after the bank lifted rates by 1% in the space of six weeks. Rates are at or above 1% in Canada and the United Kingdom. The US Federal Reserve is widely expected to deliver a second 0.5% hike when it meets next week.
Australian investors should be prepared for more dramatic rate hikes, says Stephen Miller, an investment strategist at GSFM Funds Management.
“A supersized hike down the track is plausible if inflation continues to surprise on the upside as has happened in New Zealand, Canada and the US,” he says.
Deposit rates unlikely to climb as fast
Savers are unlikely to see the full 50bps passed on, with analysis from RateCity showing just over half of banks hiked at least one savings rate following May’s cash rate change. Among banks that raised deposit rates, many only included select savings accounts.
“Following the May RBA hike, the banks were quick to hike their home loan rates, yet two out five banks didn’t touch their savings rates,” said RateCity research director Sally Tindall.
“For the banks that did increase savings rates, in many cases only select accounts were hiked, while others stayed dismally low.”