RBA Signals Further Tightening Amid Persistent Inflation and Oil Risks

What happened

Reserve Bank of Australia (RBA) Assistant Governor Sarah Hunter stated that the central bank has not yet finished its job of bringing inflation under control, despite four interest rate hikes this year. In an interview, Hunter highlighted that higher oil costs, linked to the US-Iran conflict, are becoming embedded in supply chains, with the expectation that this effect will intensify. These remarks reinforce the view that the RBA may raise interest rates again at its next meeting on November 3. The current cash rate in Australia stands at 4.6%, a 15-year high.

Why it matters

Hunter's statements, echoing earlier comments from Deputy Governor Andrew Hauser about a materially worse inflation outlook, indicate growing RBA concern over persistent price pressures. The embedding of oil costs into supply chains suggests that inflation could become more entrenched and harder to combat. This implies that the Australian central bank is prepared to maintain a tighter monetary policy stance for longer, even in the face of falling property prices, which, according to Hunter, are not causing systemic financial stress.

Market impact

• Interest rates and bonds: Short-dated Australian government bond yields tend to remain elevated, with the market pricing in a November rate hike. The expectation of further monetary tightening increases the demand for compensation to hold these bonds.
• Dollar and exchange rates: The Australian dollar (AUD) tends to be marginally supported. The prospect of higher interest rates in Australia, compared to other economies, widens the interest rate differential, making the AUD more attractive to yield-seeking investors.
• Equities: Property-linked stocks and consumer discretionary names on the ASX remain exposed to a higher-for-longer policy path. Higher interest rates can negatively impact purchasing power and indebtedness, affecting these sectors.
• Commodities: Oil is a key swing variable. Renewed escalation in the US-Iran conflict that lifts crude prices would deepen the RBA's concern about second-round effects on inflation, raising the risk of tightening beyond November. Conversely, a sustained easing in crude prices could give the RBA more room to signal a pause after its next move.

What to watch

Close attention should be paid to the release of Australia's third-quarter inflation data, due on Wednesday. The market expects the trimmed mean measure of underlying inflation to be 3.6%, broadly in line with the previous quarter. A downside surprise in inflation data could ease expectations for a November hike. Additionally, Governor Michele Bullock and other policymakers are scheduled to appear before parliament on the same day, providing crucial insights into the direction of monetary policy.

Scenarios

Base case: The RBA hikes interest rates on November 3, driven by persistent inflation and oil risks, keeping the AUD and Australian bond yields elevated. Risk scenario: Significantly lower-than-expected third-quarter inflation could lead the RBA to reconsider the November hike, although current rhetoric suggests a strong commitment to fighting inflation.

Original source: ForexLive (InvestingLive). For information only, not investment advice.