Cash rate to hit 2.6% by February: Westpac

In its latest rate forecast update issued on Thursday, Westpac said the shift toward higher global rates has led it to lift its terminal rate for the Reserve Bank’s tightening cycle from 2.35 per cent to 2.6 per cent.

According to the big bank’s chief economist Bill Evans, the RBA will hike rates by 50 basis points (bp) in both July and August, with the August board meeting tipped to respond to what he expects to be a “very unsettling” June quarter inflation report.

“We expect headline inflation to lift 1.5 per cent in the quarter taking annual inflation from 5.1 per cent yr to 5.8 per cent yr. Underlying inflation, as represented by the trimmed mean, is expected to print 1.2 per cent in the quarter for a lift in annual inflation from 3.7 per cent yr to 4.5 per cent yr,” Mr Evans explained.

“We see the risks to these numbers to the upside,” he added.

Admittedly, Westpac’s rates rethink was influenced by the Fed’s recent 75 bps hike, which it believes will be replicated in July.

The big four does, however, remain “significantly short” of the market’s forecast terminal rate of around 4.5 per cent.

“The 2.6 per cent is broadly in line with the ‘2.5 per cent guideline’ the RBA governor has given in speeches and other commentary,” Mr Evans said.

Earlier this month, Philip Lowe told the ABC that “it's reasonable that the cash rate gets to 2.5 per cent at some point”.

“I say that because the midpoint of our inflation target is 2.5 per cent. So an interest rate of 2.5 per cent in inflation-adjusted terms is a real interest rate of zero, which in historical terms is a very low number. And I would expect that over time we want an average inflation adjusted interest rate to be more than zero,” Dr Lowe said.

Once there, following a cumulative increase over nine meetings of 250 bp, Mr Evans expects the RBA to pause.

“It would be prudent to go on hold to assess the economy’s response,” he said.

“Such a move would be the second fastest tightening cycle since 1990, exceeded only by the 275bp increase over five meetings in the second half of 1994.”

In fact, according to the chief economist, moving swiftly to reverse an over-stimulatory policy setting and then pausing before moving into the contractionary zone is “the best approach” and one that is “most likely” to avoid the damaging overshoot the bank is forecasting for the FOMC.

As for inflation, Mr Evans is confident that the December quarter will see the peak in both headline and underlying inflation, which he placed at 6.6 per cent and 4.8 per cent, respectively.

He then expects the March quarter inflation report to provide evidence that the slowing in demand and the freeing up of supply has brought demand and supply into closer alignment, easing inflation pressures.

Moreover, the economist noted, the evidence around the sharp slowdown in the US economy will likely be a signal to the board that steady policy is appropriate.

But Westpac’s optimism isn’t shared by the markets.

In fact, Mr Evans admitted that markets have no sympathy with Westpac’s view that the RBA can chart this course.

“They would point to the unsustainability of Australia’s cash rate settling 87.5bp below the federal funds rate,” he explained.

Mr Evans, however, argued that Australia’s “soft landing” will put the RBA in a much favourable position, one that will allow it to hold rates steady in 2023 and 2024 as inflation gradually eases back into the 2-3 per cent target zone.

“After the FOMC is forced to reset policy in the aftermath of its economy stalling and potentially falling into recession, the RBA cash rate would settle around 50bps above the federal funds rate by the second half of 2024.”

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