RBA to Raise the Cash Rate by 50 bps, AUD

Reserve Bank meeting is on 6th September. It is expected that the cash rate will be raised by 50 basis points to 2.35%.

The best approach will be to strengthen the statement we saw last month, not on a pre set path and following Chair Powell, at some point it will be appropriate to slow the pace of tightening while emphasizing that the cycle may have considerably further to run. Raising the cash rate by 50 bps will move the cash rate into the neutral zone.

The 2.5% estimate from the RBA assumes a zero real rate and a nominal component equal to long term inflationary expectations which are judged to be 2.5%. The challenge contain inflationary expectations in this cycle will be formidable given the current evidence that both businesses and households are becoming accustomed to rising prices and short-term inflationary expectations are rising quickly.

Holding the cash rate at 3.35% through 2023, the neutral setting of 2.0% is a necessary condition for the Bank to bring inflation down close to the 3% target-the top of 2-3% range. But there will be a price to pay for such success-the economy to grow by only 1% in 2023-well below the trend rate of growth of around 2.5%.

Central banks are likely to be able to restore inflation to their pre Covid targets through aggressively slowing demand over the course of the next few years. In facing these major structural changes to the global economy, they may have to accept higher inflation targets once they rebalance policy settings to revitalize demand and restore their economies to potential growth in the future.