PREMIUM Economic forecasting is a tough gig (just ask the Reserve Bank governor Philip Lowe), but all four major banks agree that the ‘peak cash rate’ is nigh.
In the 16th century, if you wanted to learn what the future held and what course of action you should take to make yourself more wealthy, you’d have to consult a specularii. Nowadays, it’s the economists who people consult in order to know what the future holds, particularly when it comes to the cash rate and what it means for their mortgages.
But, as we now know, predicting the cash rate on a long-term trajectory is notoriously difficult.
This content is available exclusively to
The Adviser premium members.
Looking into the crystal ball
Back in 2021, hundreds of thousands of borrowers entered the property market and took on mortgage debt, with many expecting that the cash rate wouldn’t increase from its record-low setting of 0.10 per cent (brought in as an emergency measure during the COVID-19 pandemic) until 2024. The reason for their belief that the cash rate would remain at its record-low level for four years? It’s what the central bank governor, Philip Lowe, suggested.
In February 2021, Mr Lowe’s statement on the Reserve Bank of Australia’s monetary policy decision said: “The board will not increase the cash rate until actual inflation is sustainably within the 2–3 per cent target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. The board does not expect these conditions to be met until 2024 at the earliest.”
As such, between March 2021 and May 2022, more than $30 billion of new mortgages were written each month — record-high levels.
But, by May 2022, things looked very different than expected. The economy was still growing strongly, wages growth had ramped up, the unemployment level had dropped, but the Russian invasion of Ukraine had led to rapidly rising inflation. In May 2022, the RBA therefore made the move to increase the cash rate by 25 bps, two years ahead of its forecast. Since then, it’s gone up nearly every month — rising by a whopping 400 bps (at the point of writing) and causing frustration and regret among many borrowers.
As such, the RBA governor has apologised for the language he used at the time, acknowledging last year: “I’m certainly sorry if people listened to what we’d said and then acted on what we’d said and now regret what they had done.”
But trying to predict the cash rate isn’t only tricky on a long-term basis, even short-term forecasts are being ripped up and rewritten. Just look at the cash rate forecasts from the major banks. Very few economists expected the cash rate to move in May or June 2023, but, in both months, the central bank added 25 bps to the cash rate.
Speaking in mid-June, Gareth Aird, the Commonwealth Bank of Australia's (CBA) head of Australian economics, said: “The RBA’s tightening cycle has been incredibly aggressive. The annual rate of inflation is currently much higher than is desired. But we thought following May’s 25-bp rate increase, the RBA board would let the ‘long and variable’ lags of monetary work their way through the system with the objective of ‘keeping the economy on an even keel’.
“We have updated our RBA call in light of the 25-bp rate hike at the June board meeting.”
Why have forecasts been changing?
Predictions for when this tightening cycle will end — and what the cash rate will be when it does (peak cash rate) — have been changing thick and fast.
In January 2023, several major bank economists had forecast that the cash rate would peak at 3.85 per cent and that this would happen in May. However, with inflation remaining persistently high and unemployment still at near-record lows, these were scrapped in favour of a 4.1 per cent terminal rate.
When the RBA moved the cash rate to 4.1 per cent in June, the major banks hiked their cash rate peaks to 4.35 per cent — with most suggesting August was the most likely month this would happen. But, just weeks later, forecasts shifted once again once Labour Force data showed that unemployment remained at near-record lows and Mr Lowe delivering a speech in June stating that “some further tightening of monetary policy may be required, but that will depend upon how the economy and inflation evolve”.
As such, all four major banks now expect that the peak cash rate could be 4.6 per cent, with hikes this month and next (*accurate at the time of writing at the end of June).
For example, NAB has noted that the central bank had previously been “treading carefully” in an attempt to hold onto labour market gains and not unnecessarily risk a material downturn, but given high and sticky inflation and uncertainty of any easing in prices globally, the RBA is “squaring up some of the risks that have previously been all to the upside.”
Both ANZ and Westpac also both hiked their forecast for the cash rate peak to 4.6 per cent, up from the previous terminal rate forecast of 4.35 per cent after seeing stronger-than-expected Labour Force figures.
“The May Labour Force Survey tips the balance on our August call. It showed an increase in employment of 76,000, outstripping even our top-of-the-range forecast for a 40,000 bounce from a small decrease in April that looked to be mainly due to an Easter-related seasonal anomaly,” Westpac’s chief economist Bill Evans said.
“The evidence of strong ongoing momentum in the labour market is sufficient to trigger the ‘considerable risk’ of an August rate hike in our central forecast.
“We now expect a further final increase in the cash rate of 0.25 per cent to 4.6 per cent at the August board meeting for a peak in the cycle of 4.6 per cent.”
CBA is the outlier at the moment, with CBA’s Mr Aird suggesting that a 4.35 per cent peak rate is likely (and most likely to occur at the August board meeting).
He conceded that “the risk is a 25-bp rate hike earlier in July” and that there would therefore be back-to-back hikes in July and August. However, after the consumer price index (CPI) data was released on Wednesday (28 June), Mr Aird said the probability of a July hike was diminished. While rents and market services are still showing signs of inflation accelerating, the risk of a July hike is “not zero”, Mr Aird said, but it is less than likely now.
Indeed, the CPI data for May showed that inflation had actually dropped more than expected (to 5.6 per cent in May, the lowest annual pace since before this rate hiking cycle started), the third monthly decline over the past six months.
Mr Aird suggested that had the CPI been 6.3 per cent or above, a July hike would have been more likely (because such an outcome would be inconsistent with the RBA’s inflation forecast of 6.3 per cent over the year for Q2 23).
“The monthly CPI printing at 5.6 per cent over the year instead increases the chances of an on‑hold decision in July,” the CBA economist said yesterday (28 June).
“We then expect a hike in August to 4.35 per cent after the full quarterly CPI is released in late July and the RBA staff refresh their economic forecasts as part of the August Statement on Monetary Policy.”
When will rates ease back?
While many had expected the RBA to start cutting rates by the end of this year, the bank economists are now suggesting that the cash rate won’t start coming down until next year.
NAB has suggested that cuts will occur “from around mid-2024”, with the expectation that the cash rate will drop to 3.10 per cent by the end of 2024.
Similarly, CBA thinks the cash rate will drop to 3.10 per cent at the end 2024 but suggests the cutting cycle will start earlier, in the first quarter of 2024. It then suggests there will be 125 bps of easing in 2024 (50 bps of rate cuts in Q1 24 and further 25-bp rate cuts in each of Q2 24, Q3 24, and Q4 24).
Westpac has also pushed back its forecast for the easing cycle from February 2024 to May 2024 but thinks the official cash rate will actually be below 3 per cent by the end of next year.
“Next year, with labour markets remaining tight for longer than we expected back in March, the RBA board will require further convincing that the inflation path will land within the 2–3 per cent target zone by June 2025. They will have little choice but to hold off on the much-needed rate relief by three months,” Mr Evans said.
“Accordingly, we now expect 25-bp rate cuts in May; August and November 2024 prior to further cuts in 2025 eventually bringing the cash rate below 3 per cent, our estimate of ‘neutral’, by year end.”
ANZ is a notable outlier in its cash rate call, however, suggesting that the RBA won’t start easing back the tightening cycle until November 2024 and will deliver two 25-bp rate cuts in the final quarter of 2024 rather than one. As such, ANZ expects next year to end on a cash rate of 4.1 per cent.
[Related: More banks expect rate hike in both July and August]
