Was it a pause or a dither?
Against all expectations, the RBA resumed monthly raising of the cash rate this week, moving the official rate up 0.25% to 3.85%.
This took markets by surprise – the Australian share market fell and the AUD immediately rose after the announcement.
The US FED also increased its official cash rate this week by 0.25%, bringing the FED Fund’s rate into a range of 5% to 5.25%.
This week’s cash rate increase in Australia moved the spread between the cash rate and the ten-year bond rate into what is called a ‘yield curve inversion’, for the first time in over a decade. This is where the cash rate (now 3.85%), is higher than the rate on the ten-year government bond (which is now 3.4%).
The message from both the RBA and the US FED was clear – interest rates will have to stay higher for longer, and maybe increased, until the inflation reduction job is done.
The RBA’s view is that inflation is still too high and a long way from its target of between 2% to 3%. Whilst goods inflation is falling, services sector inflation has the RBA worried.
Ongoing tightness in labour markets has kept the unemployment rate fixed at around the 3.5% level for nearly twelve months now. The RBA is clearly worried wage pressures remain at elevated levels. This is adding further strain on their ability to lower inflation levels that are currently sitting well above their targets.
The RBA will also be watching the property sector and especially the bounce in property prices over the past two months. Recovering house prices, ongoing high employment demand, and concerns over wages growth in the services sector, all support its view that inflation may stay higher than expected.
The RBA mantra is to go hard before inflation becomes entrenched. In other words, it is better to take the medicine now rather than requiring life support later!
The next three to six months will be strategic for both Australian and US investors. Evidence is already emerging that consumers are restricting their purchasing decisions, and businesses are becoming more cautious, so the next few months will be key.
The US FED confirmed this week that the chance of a US recession remains elevated. Clearly both the FED and the RBA want to take some demand out of the labour market, though this will come at a cost of a higher unemployment rate.
Next week’s very important Australian federal budget will need to be reviewed carefully. Too many big spending projects would only add fuel to the inflation problem and would encourage more RBA rate increases.
Only minor changes are expected that would affect superannuation and investors. The single rumoured change for superannuation is further clarification about the proposed higher tax rate on superannuation balances above $3M.
The remaining budget outcomes appear to be:
Cost of living
- Relief for households around cost-of-living challenges
- Concessions for businesses to incentivise investment in energy efficiencies
- Reforms and cost savings for regular prescription medicines
- Changes to cigarette taxes and regulation around vaping
- Changes to aged care, particularly around higher wages
- Higher Petroleum Resource Rent tax in the energy sector
- Several smaller increases to targeted welfare payments
- Better management of NDIS spending
- Review of all existing and planned projects, looking for cost savings, given the price of the nuclear submarine deal.
Full details will be sent next week following the budget.
Please don’t hesitate to contact me should you have any questions.
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