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What is the RBA’s next move?

The RBA is expecting inflation to peak at around 7% in December and begin to cool down early next year so why is the RBA's Governor Lowe positive that a recession is unlikely for Australia?

This is a busy week for the RBA and its Governor with three reports released from Australia's central bank on Tuesday to help traders identify the central bank’s next move and of course, their investment strategy moving forward.

Inflation

The RBA now expects inflation to peak at around 7% in the December quarter versus its 6% prediction in May. This price rise is based on external and internal pressures including the increase in petrol and the availability of new cars.

Petrol prices in Australia have increased by 37% over the past year which alone adds around 1% to headline inflation (now 5.1%) while disruption to global production and the solid internal demand from the pandemic is significantly affecting the fastest-growing price in two decades.

However, the RBA didn’t anticipate the high-flying inflation rate could maintain its current pace into the next year and instead believes the consumer price index (CPI) will begin to decline for three reasons.

First, pandemic-related supply problems should be gradually resolved in the next six months as companies adjust to their new operating environment. Second, the current decades-high inflation rate is raising the bar for future comparison, meaning that prices have to keep increasing at an extremely elevated rate to maintain the current 5-7% growth rate.

The third factor relies on the central bank’s monetary policy and the tools available. The outlook of high-interest rates globally, which are set to be above 2% for most developed countries, should help to rebalance the demand for goods, services and supplies in the market. In that case, the irrational price movement can be stabilized.

Interest rate

Two weeks ago, the Australian central bank surprised the world with a 50 bps hike but Governor Philip Lowe promised that there won’t be any more surprises at the July meeting, signalling that the RBA will 'only' raise interest rates between 25 to 50 basis points to lift the cash rate to 1.1% to 1.35%.

Nevertheless, the money market is seemly holding a different view on the interest rate outlook. For the near term, the market bets on a 65 to 75 basis point hike in two weeks and for the longer period, the futures market has priced in an RBA cash rate of about 3.7% by year’s end.

The next big event to impact the RBA’s view on the rate will come after the July meeting when the second-quarter inflation data is published on July 27th. The new information may change the rate maker’s assessment of the size of hikes needed if inflation turns out to be too hot to ignore.

Recession

Despite admitting the board of the central bank was very concerned about the downside risks to the economy, Governor Lowe was positive that a 'recession is out of the horizon' for Australia.

Governor Lowe does have sound reason to support his bold statement as evidence shows that domestic demand has been resilient even with winter virus outbreaks and the floods on the east coast. As such, GDP growth for the June quarter is anticipated to grow at the annual rate of 3.3%, lower than the previous two quarters but still higher than the pre-pandemic levels.

Furthermore, the combination of rising wages in a tight labour market and a high ratio of household savings should help Australian families to overcome the increasing price to some extent.

Overall, although GDP growth had slowed in the March quarter, Australia’s economy is still a safe distance away from worrying about a recession.

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This information has been prepared by IG, a trading name of IG Australia Pty Ltd. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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