Hawkish RBA Hold Expected in August After Benign Break on Inflation

Downside surprise on inflation removes case for rate hike in August. Downbeat narrative on supply in question.

• We no longer expect rate hikes by the RBA this year. Inflation has been more benign than we feared and the RBA forecast. The substantial pass-through of higher energy costs seen in the early phase of the Middle East conflict has not been followed up in recent months. This is welcome – we took no pleasure in our prior hawkish view on pass-through, and so monetary policy.
• There is still a risk of a hike in November if inflation picks up again in Q3. But that is not our base case. Meanwhile the timing of the eventual unwind of the recent hikes (August 2027 start) has not been shifted by the latest data, but we will continue to assess new information.
• Ever since the June meeting’s pause, RBA communication has been signalling that they think they are not finished hiking rates. Inflation is too high and while the economy is slowing, that is – as the Governor noted in yesterday’s Q&A – “part of the plan”. We therefore expect the communication of the RBA to stay hawkish and not rule out further hikes, similar to the language in June.
• But it all depended on the inflation outlook, and the Q2 data show this has broken the other way, below our (and the RBA’s) expectations. In particular, market services inflation and the all-important housing-related components both came in below expectations. If underlying inflation had been in line with our (and the market’s) forecasts, a rate hike in August would have been more clearly on the table at the next Monetary Policy Board meeting. Although we still expect the Board will debate the case for a hike, things have not turned out in a way that supports the case for one.
• Even if inflation had turned out as forecast, there would have been arguments made against a hike in the Board room. The labour market has turned out a bit softer than the RBA expected, with the participation and unemployment rates both higher in the June quarter than the RBA forecast in May. Revisions to history for underemployment could also be view-changing for the RBA. But our read of the communication and RBA forecasts was that below-expectation inflation was needed to rule out the hike, which is what we got.
• In addition, as we highlighted last week, the downbeat view about potential growth in supply capacity might not be shared by all Board members. Treasury’s forecasts for labour force participation and assumptions on trend productivity growth are both notably higher than the RBA’s. Had inflation turned out differently today, a split vote on a hike would have been quite likely.
• As we have been noting for some time, we think the RBA has been overly bearish on the trend growth in supply capacity. This is one of the reasons why our end-point for underlying inflation was below the RBA’s, even though we had been slightly to the upside of their May forecasts in the near term. The more benign inflation data calls the RBA’s supply view into question even sooner than we had believed.