The RBA is worried about stubborn inflation

June 21 2024

While other central banks cut rates, Australia could do the opposite.

Investors are always pondering the likelihood that central banks will alter their cash rates, based on prevailing readings on economic growth, employment and inflation.

One way to track what investors think collectively about the outlook for cash rates is to analyse the pricing of relevant derivatives contracts.

To glean expectations about the Federal Reserve’s intentions for the US cash rate, CME Group, which operates four key US exchanges, has created a tool that tracks Fed Funds (or cash)

The CME FedWatch Tool1 on June 12 indicated there was 57.5 per cent probability the Fed would cut the US cash rate by 25 basis points at its September meeting.

Investors are so pricing Fed Funds futures because the US economy is slowing, notwithstanding the healthy employment market, and inflation is cooling. The US economy only expanded at an annualised 1.3 per cent in the first quarter of this year, down from 3.4 per cent in the preceding three months.2

US consumer inflation has slowed from 9.1 per cent in mid-2022 to 3.3 per cent (12 months to May).3 The Fed’s preferred inflation gauge is even lower at 2.7 per cent (12 months to April).4 The Fed has an inflation target of 2 per cent.

Other major central banks have already reduced their key rates. In March, the Swiss National Bank became the first central bank of an advanced economy to cut rates. In May, Sweden’s central bank did likewise.5 So far in June, the Bank of Canada and the European Central Bank cut rates.

In Australia, what is market pricing saying the Reserve Bank of Australia will do to the cash rate over the rest of 2024?

While Australia lacks a FedWatch equivalent, derivative prices show that stubborn inflation could prompt the RBA to increase the cash rate from the 4.35 per cent it has stood since November, to return inflation to its target of 2 to 3 per cent.

Take what happened on May 29 when a report showed consumer inflation rose a higher-than-expected 3.6 per cent for the 12 months to April. On that day, overnight index swap trading placed a 27 per cent probability that the RBA will increase rates at its policy-setting board meeting in September.6

For her part, RBA Governor Michele Bullock on June 5 told a senate committee the central bank was prepared to “take action” – read, raise rates – to reduce “the cost of higher inflation”.7

When other central banks are leaning towards rate cuts (except the Bank of Japan, which raised rates in March for the first time in 17 years), why might Australia’s be contemplating an increase?

The biggest reason is that annual inflation in Australia is not slowing quickly enough from its peak of 7.8 per cent in 2022.8

Inflation is proving ‘sticky’ because the prices of education, financial services, food, healthcare and rents are rising on strong demand and constrained supply.9

One reason why inflation is proving hard to tame is the RBA did not raise its key rate by as much as its global peers. Other major central banks mostly increased key rates to 5 per cent or higher.

But we are not expecting the RBA to increase the cash rate. Higher mortgage rates, steeper power bills and rising taxes are squeezing Middle Australia. Consumers are restricting spending and the economy is struggling. A government report on June 5 showed the economy only expanded 1.1 per cent in the 12 months to March (over which time GDP per capita slid 1.3 per cent).10 Tough times don’t need to become tougher.

Note that market pricing related to future cash rates can change suddenly on an event or unexpected information. Note too that derivatives pricing can incorrectly predict what central banks might do.

Even allowing for these qualifications, mortgage owners can take comfort that the market is pricing that the most likely outcome, is no RBA rate increase in 2024.

[1] The CME FedWatch Tool is found at:
[2] Gross domestic product, first quarter 2024 (second estimate) and corporate profits (preliminary).’ Bureau of Economic Analysis. 30 May 2024.
[3] ‘Consumer price index summary.’ US Bureau of Labor Statistics. 12 June 2024.
[4]‘Fed’s Favored Inflation Gauge Cools, Spending Unexpectedly Drops.’ Bloomberg News. 31 May 2024.
[5]‘Switzerland surprises with rate cut, moving ahead of ECB and Fed.’ Bloomberg News. 21 March 2024.
[6]‘Australia’s elevated inflation suggests RBA to extend pause.’ Bloomberg News. 29 May 2024.
[7]‘RBA won’t hesitate to act if inflation sticky, Bullock says.’ Bloomberg News. 5 June 2024.
[8] ‘Consumer price index, Australia.’ March quarter 2024. Australian Bureau of Statistics. 24 April 2024.
[9]‘Monthly consumer price index, Australia.’ April 2024. Australian Bureau of Statistics. 29 May 2024.
[10]‘Australian National Accounts: National income, expenditure and product.’ Australian Bureau of Statistics. 5 June 2024.

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