Vanguard’s Senior Economist, Alexis Gray has provided the following reaction in response to this afternoon’s RBA 50 bps rate hike.
RBA announcement and market reaction
The Reserve Bank of Australia (RBA) raised the cash rate by 0.50% today as we had anticipated, taking the cash rate to 1.85% for the first time since mid-2016. This rate rise was largely anticipated by markets, and as such, there was little market response. The decision follows the release of June quarter inflation figures last week, which revealed core inflation running at 4.9% and headline inflation at 6.1%.
The RBA also published new quarterly forecasts for GDP and inflation. GDP growth was downgraded to 3.25% from 4.25% for 2022, in line with our own forecasts. Inflation was also upgraded to 7.75% from 6%.
The economic outlook
According to the OECD’s weekly activity tracker, Australian GDP growth has been tracking around 4% in July. That said, there are early signs that economic momentum may be fading. Consumer confidence has fallen to its lowest level since depths of the pandemic, retail spending has slowed every month since February, and house prices contracted at a national level. In addition, global growth momentum continues to diminish, and inflation remains stubbornly high. As a consequence, we forecast Australian GDP growth to slow in 2022 to 3.0-3.5% and place the risk of recession at 35% over the next 12 months, and 45% over the next 24 months. Indeed, what stands out most about this rate hiking cycle when compared against recent history is that the cycle may end, not because inflation is on track to hit the RBAs 2-3% target, but due to recession.
Also read: US Federal Reserve In Midst of Aggressive Rate Hike
We expect the RBA to lift the cash rate to at least 2.5% by year end then take the summer to assess the impact of higher interest rates on economic activity and inflation. If, as we expect, inflation remains in the high single digits by early 2023, the RBA will likely raise the cash rate next year above 3%, which is our estimate for the long-run neutral (equilibrium) interest rate.
Implications for investors
Slowing growth momentum and rising interest rates will continue to serve as a headwind for investors, although we certainly hope the worst is behind us.
There is a silver lining to the recent decline in markets. Because of lower current equity market valuations and higher interest rates, our analysis is now projecting slightly higher long-term returns in comparison to previous modelling.
Our 10-year annualised return forecasts for global equity markets are largely 1.5 percentage points higher than at the end of 2021. And in good news for bond investors, our fixed income return forecasts in many regions are 1.5 percentage points higher. Rising yields may detract from current prices of bonds, but that means higher returns in the future as interest payments are reinvested in higher-interest bonds.
