The Reserve Bank of Australia (RBA) meets tomorrow for its monthly interest rate decision.
Last month, as you'll recall, the RBA opted to raise the official cash rate for the first time in a decade. The benchmark interest rate was lifted from the historic low of 0.10% to the current 0.35%.
While the 0.25% hike fell in the middle of consensus expectations, the S&P/ASX 200 Index (ASX: XJO) still fell 0.4% on the day.
Image source: Getty Images
Why are rates going up?
Do you remember that 'stubbornly missing' inflation central banks were desperately trying to stoke? Or even the occasional fearful murmurings of, gasp, deflation? How about negative interest rates?
Astoundingly, all of those were still on the cards just a year ago.
But no more.
Inflation figures in Australia hit 5.1% in the first quarter of 2022, well above the RBA's target range of 2% to 3%. And according to new Federal Treasurer Jim Chalmers, inflation is likely to move higher from here, putting pressure on the RBA for further interest rate hikes.
According to Chalmers (quoted by The Daily Telegraph):
It's now really clear that the inflation challenge that Australians are facing is worse. People should anticipate that it will be higher than it is now. Significantly higher… This is the defining challenge in the economy. Not easily fixed, not easily addressed. But a challenge, which is even more substantial than my predecessors 'fessed up to.
What's the RBA interest rate decision likely to be?
You'll be hard-pressed to find any analysts predicting the RBA will hold off on a second consecutive monthly interest rate hike.
But how high can ASX investors expect the central bank to go?
According to market analyst at City Index Tony Sycamore:
The main uncertainty is whether the RBA lift the cash rate by 25bp to 0.60% as it did in May. Or a 40bp increase to 0.75%, back to where the cash rate was pre the COVID-19 pandemic and to realign with the 25bp increments it has historically moved the cash rate by.
Sycamore explained that ASX investors and analysts alike remain uncertain of the RBA's upcoming move, largely because almost no one got the last 0.25% interest rate hike call correct.
A Bloomberg survey of 30 economists held before May's RBA meeting revealed five economists thought the bank would hold off on raising the rate; 20 thought the RBA would boost the cash rate by 0.15%; and the other five forecast a 0.40% rate hike.
With the cash rate historically pegged in quarter percentiles, none of the 30 economists had predicted the 0.25% increase, which lifted the cash rate to an odd 0.35%.
As for tomorrow, the majority of economists are forecasting a 0.25% interest rate boost from the RBA while most of the rest believe we'll see a 0.40% increase. This would bring rates back in line with the quarter percentile mark, at 0.75%. Goldman Sachs is the standout, with a hawkish forecast of a 0.50% rate hike tomorrow.
"Elsewhere the interest rate market is priced for 36bps of rate hikes next week and for the cash rate to reach 2.50% by year-end," Sycamore said.
Noting that "the minutes from the May meeting showed the Board discussed three options, including a 40bp hike", Sycamore concluded:
Considering all of the above, a 40bp rate hike is most likely on Tuesday that will take the cash rate to 0.75%. The RBA are then expected to deliver another 75bp of hikes (25bp each in July, August and November), taking the cash rate to 1.5% by year-end.
