Summary
- RBA to hold meeting on 7th June 2022 @ 2:30pm.
- Of 23 market economists surveyed by Bloomberg, 11 forecast a 40 basis point increase in the cash rate to 75 basis points. Eight expect 25 basis points and three expect 50.
- A 40bps rate hike can further dent the already low consumer confidence in the housing market, with housing prices already starting to drop from May’s rate hike, first time since COVID.
- Financials, Consumer Discretionary/Staples benefit from rate rises on a whole, with Real Estate & Industrials generally feeling the pinch from higher financing costs and reduced CAPEX.
- 25bps sounds the most logical given the RBA are a patient bunch and like to observe conditions.
The RBA is scheduled to meet on Tuesday, 7th June 2022 at 2:30pm AEST to deliver a potential 2nd rate hike in 12 years. As we're well aware, the RBA began normalising the cash rate in May where they increased the rate from 0.1% to 0.35% by 25 basis points after a prolonged period of a near 0 cash rate. With the impending decision on Tuesday for June's meeting, three things are certain, death, taxes and the RBA hiking at least 25bps. Most economists agree that a rate hike is imminent with the chance of anything less than 25bps being almost negligible.
In order to understand the RBA's rhetoric to forecast Tuesday's decision, we will review their commentary from the May Board Minutes. "Members considered three options for the size of the rate increase at the present meeting –raising the cash rate by 15 basis points, 25 basis points or 40 basis points. Members agreed that raising the cash rate by 15 basis points was not the preferred option given that policy was very stimulatory and that it was highly probable that further rate rises would be required. A 15 basis point increase would also be inconsistent with the historical practice of changing the cash rate in increments of at least 25 basis points. An argument for an increase of 40 basis points could be made given the upside risks to inflation and the current very low level of interest rates. However, members agreed that the preferred option was 25 basis points. A move of this size would help signal that the Board was now returning to normal operating procedures after the extraordinary period of the pandemic. Given that the Board meets monthly, it would have the opportunity to review the setting of interest rates again within a relatively short period of time, based on additional information.”
It is quite clear that the 15bps scenario is out of the question, so that leaves two options with 25bps or 40bps.
25bps scenario
May's meeting increased the rate by 25bps as this was seen the most appropriate at the time and was consistent with historical practice. Three key data publications will assist June's decision 1) Q1 22 Wage Price Index, 2) April's employment and 3) Q1 22 GDP/National Accounts. Q1 22 WPI rose by 0.7% q/q and 2.4% y/y (RBA's preferred 3.5%). This indicated that wages growth is moving higher in steady fashion. The unemployment rate printed in line with market expectations at 3.9% which supports a "normal" rate hike, rather than an aggressive one. We saw that real GDP rose by 0.8% in Q1 22 where household consumption, business investment and public demand rose strongly with inventories adding to the mix which reflects a very strong GDP result and a healthy economy, in line with market expectations.
Trade balance was in surplus $10.49b with net exports up 1% and net imports down 0.7%. The low Aussie dollar around 68.5c to 70c range was very supportive of exporters as they got more bang for their buck. Importers on the other hand had to pay more AUD to obtain goods from overseas which restricted their trade/orders. On these releases alone, the RBA won't appear to require an aggressive hawkish stance to increase the cash rate by 40bps, making 25bps more appropriate as all data was more or less in line with expectations.
40bps scenario
As the RBA stated in their minutes "An argument for an increase of 40 basis points could be made given the upside risks to inflation and the current very low level of interest rates". Australia's annual inflation rate (5.1%) is not as bad as the US (8.3%) or even our Trans-Tasman neighbours New Zealand (6.9%), so it wouldn't make sense to be as aggressive as them when considering rate hikes. You could argue that the RBA are quite patient folk as they were one of the last Central Banks to begin the tightening cycle, which could suggest they are happy to remain patient and monitor economic conditions and how it reacts to incremental changes on a monthly basis.
One reason for them to consider the 40bps hike would be that it would bring the cash rate to a "conventional" figure of 0.75% (25bps increments). But this in itself is not sufficient justification to go for 40bps when the economic conditions aren't as bad as other jurisdictions. Even still, the RBA have many more months left in the year to increase the cash rate if need be. An extra 15bps won't make any material difference to inflation. What would also be important to consider is consumer sentiment in the household sector which is presently quite low. Many households/businesses were borrowing with the expectations that the RBA wouldn't change the cash rate "until 2024 at the earliest". However, that didn't work out too well now did it?
Implications on Housing & Equities
Although the RBA doesn't focus on dwelling prices, they are very aware of the relationship between house prices, consumer sentiment, spending and financial stability. Hiking rates too quickly can risk house prices falling dramatically, which it already has begun, having a rippling effect on the economy. Preferably, it would be easier for house prices to adjust progressively with consistent incremental rate hikes, becoming less problematic for the economy.
As a general rule of thumb, higher interest rates tend to negatively affect earnings and stock prices due to rising investing/financing costs for companies, resulting in higher expenses and lower profit margins on their income statement, unless it’s the financial sector. However this is not always the case and really depends on the overall economic conditions which is quite healthy.
The sectors that generally benefit from a rising cash rate is the Financials sectors (banks/fund managers/brokers) through increased profit margins through increased spreads, Consumer Discretionary and Consumer Staples tend to maintain their growth in rising rate environments from consistent high demand, improved employment, wage/income growth resulting in higher expenditure. However, the Industrials/Mining and Real Estate sectors might be the ones facing more difficulties from rates rising, as the costs to finance equipment including CAPEX, construction and development costs will rise from higher interest rates therefore reducing their ROI, return to shareholders and ultimately a lower share price.
Risk is to the upside with the RBA and 25bps being the more logical outcome based on the above. My money is that the RBA still maintains a patient stance and will observe how another 25bps may impact the economy, gearing up for another 25bps in July’s meeting, in preparation of getting “ahead of the curve”.
By Azeem Sheriff
Markets Analyst – CMC Markets APAC & Canada
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