After ten consecutive interest rate rises, the RBA finally decided to pause. The interest rate remains at 3.5 percent.

There is always a lagged response to interest rate rises but it has taken a while for the Australian economy to slow down. On top of this, the banking crisis in the US and Switzerland has impacted global financial conditions and has no doubt given the RBA something to think about.

What the RBA said

“The decision to hold interest rates steady this month provides the Board with more time to assess the state of the economy and the outlook, in an environment of considerable uncertainty.”

“Growth in the Australian economy has slowed, with growth over the next couple of years expected to be below trend … While some households have substantial savings buffers, others are experiencing a painful squeeze on their finances.”

“The Board expects that some further tightening of monetary policy may well be needed to ensure that inflation returns to target”.

“The Australian banking system is strong, well capitalised and highly liquid. It is well placed to provide the credit that the economy needs”.

Statement by Philip Lowe, Governor: Monetary Policy Decision, 4 April 2023.

https://www.rba.gov.au/media-releases/2023/mr-23-08.html

What to expect next

Confirming that inflation has peaked

So far, the RBA’s prediction that inflation would peak in December has proved true. In February, monthly CPI fell to 6.8 percent on an annual basis (see chart below).

If this downward trend in inflation continues, the RBA can continue to pause its interest rate hikes. The RBA also notes that its interest rate increases are only now starting to really hurt households, which gives them another reason to wait and see.

But don’t expect any serious interest rate cuts for a while (except in emergencies) as the RBA does not expect inflation to fall back to its target band until mid-2025.

A slowing economy

In addition to falling inflation, the economy is also slowing down. Retail sales fell from 7.5 percent in January to 6.4 percent in February on an annual basis, continuing the downward trend since August. This will give the RBA encouragement that the tight labour market is about to soften.

Perhaps the biggest indicator of a slowing economy is the increasing inversion of the short-end of the yield curve (see chart below), which tells us that the markets are expecting the RBA to have to cut interest rates starting in the next year as the economy slows.

The difference between the current yield curve and the yield curve from six months ago (green-dotted line), also tells us that the market believes that the RBA no longer needs to raise interest rates as much as originally expected. This confirms the RBA’s story that inflation is getting under control. 

Monitoring financial developments overseas

Of course, the big wild card is now whether there will be any more banking crises in the US and Europe following the collapse of Silicon Valley Bank and Signature Bank in the US and 166 year-old Credit Suisse in Switzerland.

As a result of the crises, financial conditions in the US and Europe have tightened with their usual flow-ons to the rest of the world. Markets are now on high alert for financial contagion.

Australian banks are of course tightly regulated and would be expected to survive any global financial crisis like they did in 2008-09. But if a crisis were to ensue, the RBA may have to step in again with arms full of cash like it did in 2008-09 and would likely have to cut interest rates.  

Impact of the rate increase on the Australian Private Debt Market

Domestic banks were already tightening their credit criteria in expectations of the coming domestic recession. They will only tighten credit further given overseas developments. This should provide more opportunities for Australian private debt funds to pick up high-quality corporate borrowers.

Private debt should also continue to benefit from rising interest rates. While the RBA paused this month, this is preferred than dogmatic rate increases that would push the odds of a hard landing for the Australian economy.