RBA’s rather hawkish tone sounds strident for the state of the economy

The newly appointed Reserve Bank of Australia (RBA) Governor Michele Bullock decided to hold the cash rate at 4.1% with a hawkish tone at the October meeting. While flagging possible tightening, the RBA will be on a data dependent mode, as the 400-bps rate hike from last year becomes more effective.

Although the headline CPI slightly picked up in August, the underlying inflation has been on a downward trend after the RBA aggressively tightened from last year (Chart 1). In fact, the CPI excluding volatile items softened to +5.5% YoY in August from +5.8% YoY in July.

At the same time, the Australian economy is clearly losing steam. On the back of higher interest rates, mortgage payments sharply rose to about 9% of disposable income according to the RBA’s estimate. This has deteriorated consumer confidence and rapidly slowed nominal retail sales to +1.5% YoY in August (Chart 2). The labor market has also been cooling at the margin, with job vacancies declining -6.1% YoY in August. Furthermore, the slowing Chinese economy undergoing a real estate market crisis increases the downside risk on the Australian economy through weaker exports. With this background, a further rate hike could potentially trigger a recession.

On the other hand, the hawkish Fed increases the risk of stabilizing inflation. After the Fed signaled possible rate hike in September, the US Treasury yield has risen to the highest level in sixteen years. On the back of the monetary policy differential between the Fed and the RBA, the Aussie depreciated to AUDUSD = 0.62. Therefore, higher import prices could make it more challenging for the Reserve Bank to lower inflation within its 2-3% target range.

Going forward, our base scenario is that the RBA should remain on hold for now thanks to core inflation coming down and conscious of the rapid deceleration. Nevertheless, because headline inflation remains elevated above the target range, the CPI report to be released on October 25th and the Fed’s policy decision on November 1st will be key for RBA future decisions.

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