RBA faces ‘complicated trade-off’

Oksana Patron

11 July 2023

It will take two more rate hikes for the Reserve Bank of Australia (RBA) to take the Cash Rate to 4.60% by the fourth quarter as it is yet to get inflation under control, according to the Franklin Templeton Fixed Income (FTFI) Central Bank Watch.

The Central Bank Watch, which is qualitative assessment of the central banks for the Group of Ten (G10) nations plus China and South Korea, found that although headline inflation in Australia softened in May, employment indexes were still robust.

“A complicated trade-off- it is not getting any easier for the RBA,” Franklin Templeton noted, commenting on the RBA’s decisions.

“We expect that wage growth, although still steady, could rise as minimum wages are raised and public sector wage caps are removed.

“Relatively robust property prices in the last three months complicate this delicate balance for the central bank even further as it challenges the traditional impact of monetary tightening. Meanwhile, growth is slowing sharply as higher borrowing costs erode purchasing power.”

At the same time, Franklin Templeton expected consumption in Australia, especially for households, to remain weak and unemployment rates to likely go higher, up to 4.5%–5% (currently at 3.6%) before inflation is brought within target.

It said that while the likelihood of an outright recession was low, it could not be ruled out completely as risks to the inflation outlook remained firm.

“We expect two more rate hikes to take the Cash Rate to 4.60% by the fourth quarter, and the trajectory beyond to be data-dependent. It’s no surprise therefore that market pricing cuts in late 2023 have all but dissipated,” the manager added.

The key highlights of Franklin Templeton’s review also included:

• a short-lived pause as most central banks have turned more hawkish amid tight labor markets and sticky services inflation, with both the Bank of Canada and the RBA having ended their short-lived pause to hike again, while the Bank of England and Norges Bank surprised markets with 50 basis points (bps) hikes and the Reserve Bank of New Zealand will likely resume tightening later in 2023.
• More tightening in the pipeline: as the US Federal Reserve left the door open to at least two more 25 bp rate hikes in 2023 on stronger-than-anticipated economic data even though it refrained from hiking in June and the European Central Bank (ECB) continued hiking in June and largely committed to a hike in July on stickier core inflation and wage growth expectations.
• Behind the curve: The Bank of Japan believes inflation is yet to reach its 2% target sustainably even though fundamentals point to a shift in the status quo. While a tweak to the yield curve control is likely, a liftoff in rates is still elusive. With China’s post-reopening recovery fading fast, the People’s Bank of China remains dovish, with easing to come in the second half of 2023.