Macro Intelligence: will the RBA force another rate hike in 2024?

Article written by Nadine Blayney (ausbiz)

The RBA's balancing act

The Reserve Bank of Australia's (RBA) board meets eight times a year to decide whether to change or maintain the cash rate target, which is the interest rate that banks pay to borrow funds from other banks in the money market overnight. The cash rate is used to stimulate or slow economic activity to help the RBA meet its mandate of currency stability, full employment, and economic prosperity.

Keeping inflation within a target 2-3% band is key to the fulfilment of that mandate. The cash rate impacts the relative attractiveness of different asset classes, including fixed income, equities, and holding cash.

Market expectations vs RBA policy: interbank cash rate futures

Inflation stubbornly persists

Inflation in Australia has been out of the RBA's 2-3% target band since the June quarter of 2021, and as such, Australia has been through a rate-hike cycle which has seen the RBA lift the official cash rate 13 times to 4.35%. At its most recent meeting, the RBA left the cash rate target unchanged, saying, "Recent information suggests that inflation will continue to moderate, in line with the RBA's latest forecasts."

However, since then, the March quarter Consumer Price Index (CPI) showed an unexpected 1% rise in inflation. While the annual inflation rate was 3.6% in the quarter, lower than the 4.1% rise in the previous quarter, the rate was higher than economists had expected and proved price inflation remained particularly persistent in rent, education, and health services.

This rise in inflationary forces, or so-called 'sticky inflation', is not unique to Australia. Inflation data most closely watched by the Federal Reserve rose unexpectedly, and inflation is running at 4% in New Zealand, forcing some to rethink their expectations for the pace of interest rate cuts in 2024.

Tracking inflation in Australia: CPI movements from 2014 to 2023

Is the next RBA move… up?

Commonwealth Bank of Australia (CBA), National Australia Bank (NAB), ANZ Bank (ANZ), and Westpac (WBC) are still expecting a 25 basis point cut to come through in 2024, though the March quarter inflation data has the likes of Westpac and CBA pushing back that cut to November (from September previously).

However, many market participants are questioning whether the bank will be able to cut rates at all in 2024, including Charlie Callan at Bond Adviser who points to "pretty seismic changes" in terms of market pricing for an interest rate cut. "We have repeatedly said that there are certain parts of inflation that will not go away…we still believe that it is the case that the RBA is on hold for the rest of the year," Callan told ausbiz in the wake of the inflation data.

There are also some expecting the RBA to increase the cash rate this year, including Warren Hogan, Chief Economic Advisor of Judo Bank, who recently told ausbiz the cash rate probably needs to rise to around 5% given the ongoing strength in the economy.

"Risk management tells you that a bit of (RBA) tightening is a sensible thing," says Hogan, who expects three rate hikes in 2024. Shane Oliver, chief economist at AMP, does not think that the RBA will hike again, but it is likely to reinstate its tightening bias, adding another rate hike is now a "high risk."

Stocks for the sticky scenario

While rising interest rates or a higher-for-longer rates scenario are potential negatives for companies struggling to achieve profitability or those exposed to discretionary consumer spending, there are stocks that stand to benefit from a sticky inflationary environment. Jonathan Tacadena from MPC Markets names ASX-listed energy retailer Origin Energy (ORG), saying the stock price has benefited from pricing power which it will be able to maintain.

Origin Energy daily chart

Origin Energy sparks bullish sentiment

The consensus recommendation for Origin Energy (ORG) is a 'buy' with a mean price target of $9.64. Macquarie says Origin can afford a materially higher payout ratio and still support its transition to clean energy; it rates Origin 'outperform' with a $9.97 price target.

Charting the August '22 and February '23 surges

Inflation tailwinds for insurers

Insurers are also able to maintain their pricing power in an inflationary environment, with an added tailwind coming from the cash held on their balance sheets if rates stay higher for longer. MPC Market's Tacadena says, "If inflation continues to be sticky, they can just pass that increase onto consumers in this environment."

IAG daily chart

IAG's edge over Suncorp

Still, pricing power is not without its downside, with Macquarie saying affordability issues could increase churn and pressure market share. However, it rates IAG 'outperform' with a $6.40 price target, saying margin improvement will be easier for IAG to achieve than rival Suncorp (SUN). The current consensus recommendation for IAG is a 'hold' with a price target of $6.38.

Analyst sentiment: IAG favored as a "Buy", P&C insurance a "Hold"

RBA rate cuts: a boon for equities

If the next Reserve Bank of Australia (RBA) cash rate move is down, that would be a positive for equities broadly speaking. In analysing NEXTDC (NXT), Raymond Chan from Morgans says declining interest rates are a key price catalyst for the stock; conversely, volatility in bond yields is a risk. Morgans has an 'add' rating on NEXTDC and a discounted cash flow price target of $19 per share.

NEXTDC daily chart

NEXTDC: consensus says 'Buy'

The current consensus recommendation for NEXTDC is 'buy' with a price target of $18.50.

Comparing price action