Australian households are bracing for up to three additional cash rate increases by the Reserve Bank of Australia (RBA), following turmoil in global bond markets that has sparked speculation of the central bank’s involvement in inflation-taming efforts similar to the US Federal Reserve.
Only three days after the RBA left the cash rate unchanged at 4.1 percent, robust US labor market data prompted investors to increase bets on the need for further monetary tightening in the world’s largest economy. This triggered a significant sell-off in equities and put pressure on the Australian dollar.
Australian shares plunged 1.7 percent to a three-month low of 7042.3 points on Friday, reflecting concerns about central banks, including the RBA, being compelled to raise rates in response to external developments.
While Australian and US interest rates have not always moved in tandem, similar economic fundamentals between the two countries will likely prompt the RBA to react to offshore trends. The prospect of a more hawkish Federal Reserve places pressure on the RBA to adopt a similar stance. Market expectations currently indicate a 50 percent probability of a rate hike in August, with two rate hikes priced in by year-end.
Aussie dollar
The depreciation of the Australian dollar, reaching a low of US66.01¢, may further decline as investors seek higher-yielding currencies like the US dollar. A weaker currency raises concerns about increased costs of imported goods, including petrol, machinery, and construction materials.
This scenario could prompt the RBA to resume its aggressive monetary tightening cycle, which has already seen the cash rate rise by 4 percentage points since May 2022. The removal of the reference to “keeping the economy on an even keel” in the RBA’s policy statement suggests Governor Philip Lowe is preparing for a more significant economic downturn.
Bond yields
The surge in global bond yields following robust US jobs data has led bond traders to price in a new peak RBA cash rate of 4.71 percent. Previously, markets had anticipated a peak of 4.6 percent. The market reaction reflects the expectation of three additional rate increases, exceeding the predictions of most market economists.
Similar trends are observed globally, with swap contracts in the US and UK signaling expectations of interest rate hikes. The Bank of England may raise its benchmark rate to levels last seen in 1998, with warnings of high inflation. JPMorgan has even suggested a potential rate of 7 percent.
The actions of central banks worldwide, including the RBA, are closely tied to the anticipated US economic performance, as they hope to avoid the burden of taking independent measures to combat inflation.
The uncertain economic landscape calls for vigilance as households in Australia and beyond brace for potential interest rate increases that could impact borrowing costs and overall economic conditions.
