Why today’s RBA decision is complicated

  • By Zilla Efrat

While economists are generally pricing in a rate hike at today’s Reserve Bank of Australia board meeting, HSBC chief economist Paul Bloxham isn’t so sure.

Bloxham, who spent 12 years as an economist with the RBA, says rate rises are coming, but he believes a move in May is complicated.

He says the case for lifting rates is strong, given that underlying inflation is above the RBA's target band and the unemployment rate is ostensibly at “full employment”.

“But, as the RBA has been repeatedly stating, there is a third element. The central bank has wanted to see a solid lift in the key wage indicators – due out in mid-May and early June – before lifting its cash rate. Some observers think the RBA could ignore this guidance, but in early April, it had made it fairly clear.”

Another related complication, according to Bloxham, is the federal election on 21 May.

“The RBA is independent and will no doubt act as it sees fit to achieve its mandate,” he says.

“But raising the cash rate 18 days before an election – the first hike in over a decade – would put the RBA right in the political mix.

“A final challenge comes from the global backdrop, as the sharp fall in China's April PMIs, surprise contraction in US first-quarter GDP and the energy crunch in Europe remind us, global growth risks are to the downside.”

According to Bloxam, the consensus view among economists is that the RBA will lift its cash rate by 15 basis point to 0.25 per cent in response to the recent upside surprise to CPI inflation. This, he says, is priced in by the market.

“However, if the RBA's view really has changed and it is now much more concerned about inflation, surely a 15 basis point move is not enough. If the concerns have only increased a little, commensurate with only a 15 basis point move, why move at all?” asks Bloxam.

Another option is for the RBA to lift by 40 basis points to 0.50 per cent. “This would be commensurate with a marked change in the view on inflation,” says Bloxam. “It would also be a significant change in the RBA's narrative and the biggest move upwards in the cash rate in over 20 years. A dramatic move.”

Bloxam says both options are possible, but both would also mean that the next few weeks of local media reports and commentary on the economy are likely to be dominated by the RBA and interest rates, during the final stages of an election campaign. “There is no escaping a political implication,” he says.

Another option, one that Bloxam believes is most likely, is to keep the cash rate steady at 0.10 per cent, acknowledge the pick-up in inflation and reiterate that the board wants to see the wages figures to be absolutely convinced that inflation will now be “sustainably” on target, after a long period of being below target.

“This would be consistent with the RBA's previous guidance. Indeed, when the RBA designed this game plan, it may have had the election timing and CPI print risk in mind. This option would also allow the RBA a little more time to see how the global developments play out.

“And, one month's delay to hiking means almost nothing in terms of its macroeconomic effect. If the RBA turns out to be 'behind the curve' (only time will tell), a delay from May to June will make little difference.

“Our view is 60/40 in favour of the RBA holding steady in May. Our central case sees a 40 basis point hike to 0.50 per cent in June.”

Beyond that, Bloxam expects further hikes to 1.00 per cent by end-2022 and 1.50 per cent by the end of 2023.

While this longer-term view is well below market pricing, he says it reflects HSBC’s view that the already cooling housing market will only be able to withstand a modest set of hikes before house price falls weigh on consumer spending and the jobs market.

At that point, the RBA will stop hiking. “Equally important to our view though, is that we see significant downside risks to global growth, which we expect to come into play more fervently in the RBA's thinking in coming quarters,” says Bloxam.