If, unlike the Federal Reserve, you cannot enforce bank failures to tighten monetary policy, then surprise rate hikes may be the solution.
This is precisely what the Reserve Bank of Australia did recently, unexpectedly raising the Cash Rate Target by 25 basis points to 3.85%. Only 9 out of 30 Bloomberg forecasters predicted this move, with most predicting no change. The Bank stated that it anticipates further tightening of monetary policy to ensure that inflation returns to its target level within a reasonable timeframe, while also monitoring global economic developments, household spending trends, and the outlook for inflation and the labour market. The RBA is committed to achieving its inflation target and will take whatever steps are necessary to accomplish this goal.
The RBA cited inflation still being too high as the reason for its decision to raise interest rates, despite it having already peaked at 7%. The Bank also noted that unit labour costs were increasing rapidly, although no additional information on this matter was provided for the month. In addition, the RBA downgraded its end-2023 CPI forecast to 4.5% yoy from 4.8% yoy following weaker-than-expected CPI data in April. The Bank also lowered its forecast GDP growth for end-2023 by approximately 35 basis points to 1.25% yoy. The RBA’s statement included a somewhat softer tightening bias, stating that “some further tightening of monetary policy may be required” instead of the previous “may well be needed.”
The decision to resume a tightening cycle after only one month of pause, following a 10-month cycle, was surprising. This was especially true given the weaker CPI report in the interim and the RBA’s tendency to observe multi-month pauses. It is possible that concerns about spillovers connected to the US banking crisis, although this did not prevent the Fed/ECB from hiking, or considerations around the RBA Review may have explained the brief pause in April.
Financial markets were not anticipating a significant increase in interest rates, with only 3 basis points of tightening priced in before the meeting. Therefore, the rate hike announcement and hawkish guidance caught the markets off guard. This caused the Australian dollar to surge, with it probing 0.6700 and the top end of 1.5 billion expiry options.
The 2-year Australian note experienced a significant increase, rising by over 20 basis points from 3.07% to a peak of 3.32%. However, the gains were modestly reduced afterwards.
The surprise tightening by the Reserve Bank of Australia was met with dissatisfaction from local stock markets, resulting in a 0.9% drop in the S&P/ASX 200 index, according to Matthew Haupt, a fund manager at Wilson Asset Management in Sydney. He also added that the shocks to markets are becoming a credibility issue, and discounts must be added due to policy uncertainty.
Chamath De Silva, a senior fund manager for BetaShares in Sydney, stated that the RBA’s rate hike was a negative surprise for Australia’s equity and bond markets after the central bank’s pause in April. He also speculated that the pause might have been motivated by banking stress during March, and the unexpected rate hike came as a huge shock to the market.
Goldman strategists predict that the RBA will increase the terminal rate to 4.1%. They expect a final 25bp increase in July’s meeting, allowing the RBA to observe updates on national accounts, unit labour costs, and the annual resetting of the minimum wage. However, there is a material risk of a back-to-back rate increase in June, and the balance of risks is skewed to a higher terminal rate.