From Adam Bowe, Head of Australia Portfolio Management at PIMCO.
What happened
The RBA raised the cash rate by 25bp to 4.10% today, but it was not a unanimous decision. The board voted 5-4 in favour of lifting the cash rate, highlighting how finely balanced the decision was and how uncertain the outlook has become in recent weeks.
The key new development since the last meeting in February is the conflict in the Middle East and subsequent sharp rise in the oil price and other energy markets. While the outlook on this front remains highly uncertain, the RBA viewed the risk of higher near-term inflation and the potential implications for inflation expectations as more concerning than the medium-term negative implications for household and business spending.
What does it mean
Financial conditions are tightening materially for Australian households and businesses via higher mortgage rates, a higher exchange rate, higher energy prices, and a softer outlook for asset prices such as housing and equity markets.
While the near term risks for inflation look clear, as financial conditions continue to tighten the medium term risks to growth are increasing.
What next
We view today’s decision to increase the cash rate as pulling forward future anticipated tightening of monetary policy in response to the recent energy price shock, rather than signalling an elongated hiking cycle.
If the RBA chooses to tighten policy modestly further to bring inflation down more quickly, we do not think they will need to lift the cash rate beyond the prior peak of 4.35%. The current energy price shock is different to that experienced in 2022 on several dimensions. Most importantly, it is not occurring in conjunction with a significant positive demand shock as was the case when the world was emerging from the pandemic. The growth outlook prior to this energy shock was much more balanced, with looser labour markets, lower inflation, and monetary policy that was already on the tighter side of neutral.
With the market pricing the cash rate to peak around 4.50%, and yields on 10-year Australian Commonwealth Government Bonds around the highs of the past 15 years, we think there is considerable value in Australian duration.
