RBA Hikes Rates by 50 Basis Points
More hikes to come
The RBA has increased the policy rate by 50bps to 1.35%. This is the second consecutive 50bp hike. More hikes are likely to come as the RBA aims to push rates towards the ‘neutral rate’.
This raises the question of why the RBA increased rates by such a significant amount and what the state of Australia's economy is going forward.
Why the hike?
The rationale for the rate hike is unsurprising: inflation has been elevated globally. Australia's CPI inflation rate was 5.1% in the latest reading. However, the RBA had indicated that it could increase further towards 7%. Similarly, other countries have experienced strong inflation: the US CPI inflation was 8.6%. Inflation in Europe ranges from 7-10%, depending on the country.
Global price increases will influence Australia. For example, if LNG, Coal, or Oil increases in Europe, then those items will also increase in Australia. Natural gas and oil have seen cotinued volatility and upward pressure. Oil - and energy commodities - will also experience upward pressure from China's continued reopening. The volatility itself adds to hedging costs, which increases costs. Further, natural disasters - such as flooding - will further push agricultural prices upwards.
The RBA thus had little choice but to increase rates. The goal being to reduce demand by enough to off-set supply driven price increases.
Recession Risk? Are Future hikes coming?
The next question is whether further rate hikes are coming. The RBA has indicated that it will increase rates towards 2.5%, with rates expected to reach around 2.35%. However, the terminal rate will depend on economic conditions.
The RBA is not alone in increasing rates. The Federal Reserve has indicated that rates will reach 3.8% by 2023. However, the US economy differs from Australia's. And, US mortgage rates differ significantly from Australia's. In the US, mortgages are typically 30-year fixed rate mortgages. By contrast, Australia's mortgages are typically variable rate. Thus, a similar rate hike has a larger impact on more people in Australia. The EU has also indicated that it will increase rates, potentially by 50bps.
The concern is then whether a recession is possible. The RBA still anticipates robust GDP growth. GDP increased by 0.8% q/q in Q1 2022 (3.1%, annualized) and 3.3% y/y. By contrast, US GDP fell 1.6% q/q (annualized) in Q1 2022. And, the Atlanta Fed points towards US GDP falling 2.1% in Q2 2022. Thus, the economic situation in Australia is relatively stronger. Australia continues to experience strong employment data, with unemployment at 3.9%. That notwithstanding, there are economic headwinds. Housing sales have slowed signifciantly after the first 50bp hike. Similarly, the AIG construction index is below 50. This suggests that even a small change in interest rates can have a significant impact on economic activity in Australia. Nevertheless, the RBA appears to have a (possibly unrealistically) positive opinion of the Australian economy. Thus, especailly with a broader global slowdown, Australia is vulnerable to a recession.