Banks revise their thinking and now predict a rate rise

UNEXPECTEDLY strong inflation figures have forced a rethink on interest rates, with three out of four big banks now tipping the RBA to hike rates again by Melbourne Cup day.

Economists at NAB and Commonwealth Bank followed ANZ in changing their rates forecast on Thursday.

ANZ was the first of Australia’s biggest lenders to switch their call from an extended hold to one more rise on Wednesday, after July consumer price index figures showed underlying inflation rose 0.5 per cent in the month, well above expectations.

While ANZ and CBA predict the Reserve Bank will lift the cash rate in November, NAB’s Sally Auld and Gareth Spence think it will be even sooner, forecasting a hike at the central bank’s next meeting in September.

Even though headline inflation slowed on an annual basis from 3.8 to 3.5 per cent, the broad-based rise in underlying inflation suggests the RBA’s preferred quarterly trimmed mean measure will likely come in above one per cent in September, NAB said.

That would be materially higher than the RBA’s forecast of 0.83 per cent and indicates that the upside risks to inflation, which were repeatedly flagged by governor Michele Bullock after the August meeting, are crystallising.

“RBA officials have been very clear in recent months that, firstly, risks to their inflation forecast were tilted to the upside; and, secondly, that if those risks were realised the Board would respond with a rate hike,” Auld and Spence said in a research note.

“We think it unlikely that activity data between now and the September board meeting will be weak enough to deter the board from hiking.”

New housing costs are a particular concern for the RBA.

Despite only making up 21 per cent of the CPI basket, housing accounted for nearly one-third of annual inflation.

While growth in new dwelling costs was roughly unchanged at 0.4 per cent in July, the annual pace was still very high at 5.7 per cent, AMP economists My Bui and Diana Mousina said.

“New dwelling purchases need to come down to at least 0.25 per cent month-on-month for the Reserve Bank to be comfortable, as this is a very cyclical category that can quickly show any progress in inflation,” they said.

Given the outsized influence of construction costs on inflation, the sector has been singled out by Bullock as one area where cost pressures were flowing through from the Middle East to consumers.

Rising producer prices were being passed on by builders, she told reporters after the RBA’s last board meeting in August. 

“Others are wondering whether or not demand is strong enough for them to pass it on because it all depends on whether consumers will actually choose to pay if prices go further,” Bullock said.

“So that push and pull between whether or not it comes into the producer prices and ultimately gets passed on to the consumers, that’s what we’re going to have to be watching.”

NAB thinks the RBA might not just stop at one hike.

Minutes from the bank’s last meeting released on Tuesday showed the board believes interest rates are already “somewhat restrictive”, so another hike will tip monetary policy into firmly restrictive policy, NAB said.

The RBA board is also very mindful of the effect that more tightening could have on unemployment and that the rapidly deteriorating housing market will help slow the economy as well.

“However, risks are biased to a follow-up hike, especially if resilience in activity data emerges ahead of the November meeting,” NAB said.

While falling house prices could drive down activity by making households less willing to spend, consumption has been stronger than expected in recent months.