Inflation shock could prompt RBA to hike rates as early as next week
- Annual headline inflation rate 5.1% and core inflation 3.7%
- The current setting of official interest rates at 0.1% is no longer appropriate
- RBA dilemma: 0.15% increase next week or 0.4% next month?
- Capital markets are prepared for a normalization of interest rates.
Not if, but when and how much?
The Reserve Bank of Australia (RBA) faces the prospect of runaway inflation if it does not raise the official interest rate at its board meeting next Tuesday. This is the opinion of several leading economists in response to yesterday’s inflation data showing that the headline inflation rate is 5.1% per year and core inflation is now 3.7 %. This is well outside the RBA’s stated inflation target range of 2-3% and the largest annual increase in inflation for over 20 years. This comes at a time when interest rates are at their lowest in 40 years and unemployment is at its lowest in almost 50 years. Clearly, history is not on the side of the RBA.
The driving factors driving consumer prices higher are well documented and include supply chain cost pressures, rising fuel, groceries, higher education and rising costs. new housing. This is before wage cost pressures appear. Another emerging factor is the recent new outbreak of COVID in China which is causing lockdowns which could lead to worsening supply chain constraints for key components of manufactured goods and materials critical to the orderly functioning of the Australian economy. This confluence of events means that the current official RBA interest rate of 0.1% is no longer appropriate.
The dilemma for the RBA is that the government is in election mode and any decision not to raise the official rate next Tuesday can be seen as politically inspired. The RBA is an independent central bank and should always be regarded as acting independently.
0.15% increase next week or 0.4% next month?
If interest rates are not raised next Tuesday, there is a risk that a rate hike at a later date would have to be higher than if a rate hike were announced next Tuesday. The market consensus is that a rate hike is needed sooner rather than later, because that’s what the data already tells us: it wasn’t raining when Noah built the Ark!
A minimum increase of 0.15% in the current official exchange rate of 0.1%, bringing the official rate to 0.25%, is likely next Tuesday. Otherwise, the market is widely pricing in a bigger rise of 0.4% in June, bringing the official interest rate to 0.5%.
If it’s in the news, it’s in the price.
The market implications of an official interest rate hike, whether announced next week or next month, are likely to be moderate to neutral. Markets react badly to surprises, and any announcement of an interest rate hike by the RBA next week should come as no surprise. Interestingly, if the RBA does not announce an official rate hike next Tuesday, it could lead to a temporary market sell-off, as no change in official interest rates will come as a surprise to some investment market participants.
You cannot predict the future; but you have to prepare for it!
Inflation is here and the current setting of near-zero interest rates is no longer appropriate. Zero interest rates may explain the current historically high asset prices, but they do not justify them. Asset price inflation works for many investors (and owners), but it does little for economic growth.
This is why interest rates will soon start to normalize. Investors should prepare for this scenario as it unfolds in the weeks and months ahead.
This Post Market Wrap is presented by Kodari Titleswritten by Michael Kodari, CEO of KOSEC.