The Complex Case of Peak Rates: Weakening Signals and Cautious Outlook

The case for rates having already peaked is weakening

We started by noting that markets seem confused by recent events and their pricing may reflect this. Cash rate futures point to rates rising to over 4.6% - a further 50bp of hikes.

Our view is that this is too much and that the current cash rate of 4.1% could be the peak, though this view has certainly been damaged by the latest labour report. 

Our principal argument for a more moderate rate outlook is that we do expect to see inflation coming down over the coming months, and consequently, the pressure for the RBA to keep hiking will lessen substantially – especially as they aren’t expecting inflation to come down much over the coming quarters, so the hurdle for surprises on the downside is quite a low one.

Still, this isn’t likely to be plain sailing. What was once mainly a supply-side shock affecting energy and food prices has widened out to a much broader inflationary issue, with virtually all components of the CPI basket rising at a rate in excess of the RBA’s target range, and the annualised run-rate of inflation (currently about 4%) still inconsistent with getting inflation back to trend.

 

 

Further complicating the picture is the fact that despite the RBA’s tightening, house prices, which had been falling, ticked up in 1Q23. If the RBA’s tightening were sufficient to slow the economy, we would expect this to show up in housing - one of the most interest-sensitive parts of the economy.

If it isn’t, then it is probably unlikely that we will see less sensitive areas, such as consumer spending dip as much as will be required for inflation to ease. That said, the house price increase seems at odds with sharply lower consumer confidence and so for now, our best guess is that the housing bump in 1Q23 was more of a blip than a concrete turn in prices.

Nevertheless, a rapidly rising population, spurred by strong net inward migration as well as low housing supply could keep house prices and rents under further upward pressure. This area certainly bears close watching.

 

 

Conversely, the RBA has little interest in causing more hardship than needed in the residential property market, and will likely also be cautious about the outlook for commercial real estate should it squeeze growth too hard.

Banking sector metrics look extremely solid, and delinquent and past-due loans aren’t flashing any warning signs. But as we’ve learned recently in other jurisdictions, even well-regulated financial markets are not immune to adjustment problems that are associated with monetary tightening of the scale we have seen in markets like the US, the EU, or Australia. And this, perhaps, also supports a more cautious outlook on rates than that currently priced in by markets.

 

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