The Reserve Bank has confirmed that Australians can expect to see at least two more rate rises, but appears to favour a slow and steady approach over any more supersized hikes.
In its latest Statement on Monetary Policy — a quarterly guide to the bank's detailed economic thinking and forecasts – the RBA reiterated that it "expects further increases in interest rates will be needed" to ensure that high inflation does not hang around too much longer.
The Reserve Bank is careful with its choice of words, so the plural in relation to rate increases, repeating the governor's statement earlier in the week, is a clear warning to expect the cash rate to rise at least two more times before it peaks.
The RBA's current cash rate target is 3.35 per cent after Tuesday's latest rate hike, so that implies a likely peak of 3.85 per cent or above.
The RBA had shocked many Australians by raising rates in half-a-percentage point increments every month between June and September last year, double its more typical 0.25 of a percentage point moves.
However, its latest Statement on Monetary Policy indicated no appetite to return to super-sized rate moves.
"There are considerable uncertainties surrounding the outlook, and so around the level of interest rates needed to achieve the board's objectives," the report noted.
"Maintaining a steady pace of increases over several months has given the board the time to assess the flow of incoming data and any shifts to the outlook that it may imply."
Equally, the first sentence offered no reassurance that a peak in the RBA's cash rate target is imminent, leaving open the possibility that some forecasters who are tipping a peak above 4 per cent may be correct.
In fact, financial markets are currently pricing a peak cash rate around 4.1 per cent.
One cause for optimism is the bank's confidence that global inflation has peaked and is on the way down, echoing recent comments by US central bank boss Jerome Powell.
The RBA also shed a light on where inflation is coming from, finding that between half and three-quarters of it has resulted from supply disruptions, many of which are now easing as COVID cases decline and supply chains adjust to disruptions arising from the Russia-Ukraine war.
The key uncertainty for the RBA is how quickly those global trends will play out locally, given that Australia was around half a year behind when inflation was on the way up, although there appears to be no good reason why it should lag the rest of the world on price rises easing.
According to the bank, much depends on how quickly local companies choose to pass on the reduction in costs some are starting to see in their global supply chains.
"Given the importance of avoiding a price-wage spiral, the board will continue to play close attention to both the price-setting behaviour of firms and the evolution of labour costs in the period ahead," the Statement on Monetary Policy pointedly remarked.
"It will be closely monitoring how quickly declines in global costs are passed through to prices by businesses in Australia."
As it stands, the Reserve Bank is expecting inflation to be a bit higher in the short term than it was forecasting a few months ago, before dropping off more quickly in 2024 and getting back to its 2-3 per cent target range in the first half of 2025.
The RBA expects headline inflation will still be 6.7 per cent over the year to June, only slightly down from a peak of 7.8 per cent in the year to December, and still be nearly 5 per cent at the end of this year.
RBA optimistic on wages, but why?
Of course the other side of that equation is what happens with wages.
The Reserve Bank has marginally increased its pay growth forecasts, expecting the Bureau of Statistics's Wage Price Index to show annual growth above 4 per cent by June this year.
That would still be a real pay cut for workers, with annual inflation expected to ease from December's peak of 7.8 per cent to a still high 6.7 per cent by June.
It is not until June 2024 that the RBA expects wages growth to slightly exceed the rising cost of living.
However, the Reserve Bank's wages growth forecasts have historically been consistently far too high, leaving doubts about whether its current predictions will prove realistic.
Indeed, the bank's own discussions with businesses hint that predicted economy wide pay rises above 4 per cent – the bank is tipping a peak of 4.2 per cent later this year – may prove optimistic.
"Firms surveyed in the liaison program expect wages growth to stabilise around 4 per cent in coming quarters," the RBA noted.
With the large group of public sector workers seeing pay rises that have lagged well behind the private sector over the past year or so, it would take pay rises substantially above 4 per cent in the private sector to lift the WPI to 4.2 per cent.
However, there is a significant group of workers in the private sector currently enjoying pay rises above 5 per cent, at least according to the companies that employ them.
"Around one-third of private sector firms reported wage increases above 5 per cent in the December quarter. This is in contrast to the years leading up to the pandemic when very few firms reported wages growth above 5 per cent," noted the RBA from its liaison program.
"Given the current tightness in the labour market, there are upside risks to wages growth, which would boost domestically sourced inflation."
However, the liaison program also indicated that labour shortages in some industries were beginning to ease and that less firms were planning to add more staff than was the case last year.
The RBA expects unemployment to have passed its low point, and to rise to 3.8 per cent by the end of this year and 4.4 per cent by the middle of 2025.
