(Bloomberg) --
Australia's central bank gave itself wriggle room to adjust the pace of interest-rate increases if the economic outlook deteriorates after delivering the sharpest policy tightening in a generation.
“The board expects to take further steps in the process of normalizing monetary conditions over the months ahead, but it is not on a pre-set path,” Governor Philip Lowe said after hiking by 50 basis-points for a third straight month to 1.85%. The “size and timing” will be “guided by the incoming data.”
The currency declined and bonds rallied as the market interpreted Lowe's statement as an echo of Federal Reserve chief Jerome Powell's shift last week to give himself more flexibility on policy.
Yields on 10-year government bonds tumbled 9 basis points to 2.97%, the currency fell below 70 US cents and the benchmark stock index erased losses.
“While the language and sentiment are not new, the emphasis appears a little stronger in laying the groundwork back to a more modest pace of tightening,” said Su-Lin Ong, chief economist for Australia at Royal Bank of Canada.
The Reserve Bank has rapidly tightened policy, hiking 175 basis points since May, and joining global counterparts from Washington to Wellington in trying to prevent consumer prices spiraling out of control. Headline inflation in Australia last quarter was running at twice the top end of the central bank's 2-3% target.
The RBA provided some forecasts from its quarterly update due to be released on Friday. It now anticipates:
- Faster inflation at around 7.75% over 2022, a little above 4% over 2023 and around 3% over 2024
- Slower GDP growth of 3.25% over 2022 and 1.75% in each of the following two years
- Unemployment to be around 4% at the end of 2024
Higher rates feed straight through to Australian borrowers, most of whom are on variable-rate mortgages. The RBA has signaled it's trying to get the cash rate to around 2.5%, or a neutral level, while money markets are pricing in 3% by the end of the year.
What Bloomberg Economics Says...
“We see the subtle shift in forward guidance as indicating that, while the cash rate is headed well above neutral, the pace of hikes is now likely to be more measured.”
-- James McIntyre, economist
For the full report, click here
The combination of higher borrowing costs, falling property prices and a rising cost of living has raised the risk of recession. Goldman Sachs Group Inc. sees about a 25% chance of a slump and some banks are forecasting rate cuts as early as next year to ward off a downturn.
“The board places a high priority on the return of inflation to the 2–3% over time, while keeping the economy on an even keel,” Lowe said Tuesday. “The path to achieve this balance is a narrow one and clouded in uncertainty.”
There are early signs of cooling demand with the pace of retail sales slowing and internal data from major banks pointing to weakening spending trends.
The RBA “could be setting expectations for a smaller increase in the cash rate,” said Diana Mousina, a senior economist at AMP Capital Markets who expects a quarter-point increase next month. “We think today will be the end of 50-basis-point moves.”
(Adds comments from economists.)
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