On 7 March, the RBA did what was expected and raised the official interest rates by 25 bps to 3.60 percent. It was the tenth increase in a row. More increases will come this year, but we should start to see a slowdown in rate increases going forward. The Australian economy, mortgage payers, and the RBA governor will get some moments to breathe over the next six months. Dr Lowe will be particularly happy about that!

The RBA believes that inflation has peaked as predicted and that we are now heading to a soft landing, albeit with risks.

Inflation expectations and wage growth are elevated but under control. Consumer spending has come down and will fall further in the next few months as the impact of this and past interest rate rises come to bear. The slowdown in the global economy will also help push Australian growth lower.

What the RBA said

“The monthly CPI indicator suggests that inflation has peaked in Australia”.

“The central forecast is for inflation to decline this year and next, to be around 3 per cent in mid-2025. Medium-term inflation expectations remain well anchored, and it is important that this remains the case”.

“Household consumption growth has slowed due to the tighter financial conditions and the outlook for housing construction has softened. In contrast, the outlook for business investment remains positive, with many businesses operating at a very high level of capacity utilisation”.

“Wages growth is continuing to pick up in response to the tight labour market and higher inflation. At the aggregate level, wages growth is still consistent with the inflation target and recent data suggest a lower risk of a cycle in which prices and wages chase one another”.

“The Board recognises that monetary policy operates with a lag and that the full effect of the cumulative increase in interest rates is yet to be felt in mortgage payments”.

“In assessing when and how much further interest rates need to increase, the Board will be paying close attention to developments in the global economy, trends in household spending and the outlook for inflation and the labour market. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that”.

Statement by Philip Lowe, Governor: Monetary Policy Decision, 7 March 2023.

https://www.rba.gov.au/media-releases/2023/mr-23-07.html

What to expect next

Watching for slowing inflation

No turning back? If the RBA is right, inflation should continue to ratchet down from here.

In keeping with their prediction of inflation peaking in December, monthly inflation for January decreased to 7.4 percent from 8.4 percent in December on an annual basis (see chart below). The only two items which increased for the month were healthcare and insurance and financial services. The biggest fall was in recreation and culture: from 14.4 percent in December to 10.2 percent in January on an annual basis with a monthly movement of -7.2 percent.

A lot will depend on how soon service inflation and wage inflation slows. How sticky will they be?

In terms of wage inflation, the Wage Price Index increased slightly in the December quarter to 3.3 percent on an annual basis. In the background, the labour market remains tight with the unemployment rate rising just 0.1 percentage points in December. The job vacancy rate fell from 3.2 to 2.8 percent, but is still at historically high levels (see chart below).

Business indicators also remain strong, for example operating profits increased 10.6 percent in the December quarter. It doesn’t look like businesses are at the point where they will start shedding staff yet so pressure will remain on wages in the short-term.

RBA happy with inflation expectations

Despite ongoing pressure on wages, the RBA is alert, but not alarmed. This is because inflation expectations have not gotten out of control and, like monthly inflation, looks to be on the way down (see chart below).

Which way the global economy?

The US, EU, and UK are in a similar position to Australia with inflation still high and early signs of an economic slowdown. Expect higher interest rates and slowing growth going forward. Even China is expecting slower growth, with a lower than expected GDP growth target for 2023. This despite the opening up of the economy post-COVID. Together, this says that Australia should expect little economic upside from the global economy in 2023.

Impact of the rate increase on the Australian Private Debt Market

Investors in private debt will be rewarded over the next year as interest rates continue to creep up to the critical rate. So far, businesses remain strong with little weakness to worry about, although investors should proceed with caution. However, opportunities for private debt funds and investors may start to slow with business financing starting to slow (see chart below). There will still be some businesses coming from banks looking for funds going forward, but at some point this will dry up.

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