Overview

The recent drop in the unemployment rate to 3.5% is too large to ignore, particularly given the expectation that next week’s Q2 CPI release will show further very elevated inflation. We now expect the RBA to lift rates to 2.85% by the end of the year, which we consider to be around neutral if not mildly restrictive, and then to pause. Previously we had expected a Cash Rate of 2.35% by end 2022, with rates peaking at 2.6% in early 2023.

• The path towards this level is difficult to pin down – with the RBA still suggesting “the pace and size of increases will be determined by data” but also that we will likely see a “steady” series of rate increases.
• With the cash rate still well below “neutral” this points to an ongoing rapid normalisation in coming months, but given the speed there will need to be a pause to assess the impact of rate increases. That sees 50 bps at each of the next two meetings but a slowing to 25bp increments in October/November.
• Current high inflation risks a material rise in inflation expectations which could feed into the wage-bargaining process given the very tight labour market. If this were to eventuate this would pressure the RBA to move even higher.
• While we formally expect a pause in rate hikes once the RBA has lifted rates to a level it considers is consistent with inflation returning to within their target, the current high level of uncertainty around any point forecast and estimates of the neutral interest rate, means the RBA will be sensitive to material incoming data surprises as well as overseas developments.
• We have also brought forward our track for the US Fed; we now expect them to reach a (peak) fed funds rate target range of 3.25-3.50% by end 2022 (previously early 2023).

For further details, please see the NAB Monetary Policy Update – 22 July 2022