The Reserve Bank of Australia (RBA) raised the cash rate from 0.85% to 1.35% at the July meeting, which was largely in line with expectations (after having surprised the market the previous two months). As we highlighted last month, the focus will continue to be on the labour market and consumer spending. We maintain our view that market pricing of the cash rate being above 3% at the end of the year to be excessive. The labour market remains tight, and the RBA’s business liaison program is noting that wage pressure is starting to build. We noted that the Q1 Wages Price Index was below target, and we recently saw that enterprise bargaining agreements that were signed throughout Q1 similarly were largely below 3%. That said, the Fair Work Commission announced a 5.1% increase to the minimum wage which became effective on 1 July 2022.
The RBA have maintained their forecast that inflation should come back down to the 2-3% range next year, after peaking at a significantly higher rate this year. This seems reasonable, especially given the softening demand picture that is developing globally.
The major uncertainty for the Australian economy continues to be the ability of the Australian consumer to withstand higher inflation and higher interest rates. We highlighted the very soft consumer confidence data last month, indicating that the consumer is already beginning to feel the bite of inflation and interest rates. However, the May retail sales numbers were much stronger than expected, so this hit to confidence is yet to feed through into retail spending – but we expect this will come with time. It’s also worth noting that some of this spending impulse is being driven by the continued re-opening of the economy, with spending on cafés and restaurants quite strong.
At the risk of sounding pedantic, one of the notable changes in the July statement was the removal of the reference to ‘very low interest rates’ when discussing the current monetary stance. This ties into the discussion around where the neutral rate of interest is – and suggests to us that the RBA think they are getting closer to neutral. Our expectation is that a 0.5% rate rise is on the cards for the August meeting, particularly if the Q2 inflation print is higher than the RBA expects. As the RBA approach 2% though, we think the balance of risk becomes much more leveled and they are likely to be more cautious.