Australian Bond Exchange Weekly Update
Friday 28th July 2023
Key Points
- The Reserve Bank of Australia (RBA) Cash Rate is currently 4.1%pa, and the rate of inflation in the year to the June quarter has eased to 6%. Next Tuesday, the RBA will decide whether to change the cash rate, or hold as is.
- The UK cash rate sits at 5%pa, and next Thursday the Bank of England (BOE) will decide whether to continue hiking to fight a sticky 9%pa inflation rate for the calendar year to June.
- The US cash rate (policy rate) was raised to 25-5.5%pa this week, showing the Federal Reserve is remaining hawkish, despite seeing the inflation rate drop to 3% as at July 7.
- The ECB Cash Rate (deposit facility) is 3.75%pa. Inflation in the European Union (in the year to June 2023), is currently at 5.5%.
CPI data shows inflation easing, but price pressures in services hit a 20 year high
Data released by the Australian Bureau of Statistics (ABS) on Wednesday showed that annual inflation eased to 6%pa in the year to the June quarter. Though easing slightly more than the 6.2%pa forecast markets had priced in before the announcement, the data release saw a shift in investor sentiment, and the market-priced chance of another rate hike next Tuesday fell from 54% to 31%.
The markets were spot on, however, about inflation in services remaining sticky, with the cost of services climbing to their highest level in twenty years – 6.3%pa in the year to the June quarter. Markets were also right in suggesting that a substantial drop in goods inflation (which dropped to 5.8%pa in June from 7.6%pa in March) would be enough to pull down the overall annual inflation rate.
“Goods like new dwellings and automotive fuel were driving inflation [12 months ago],” Michelle Marquand, head of price statistics at the ABS, stated in the recent release. “Now price increases for a range of services like rents, restaurant meals, child-care and insurance are keeping inflation high.”
Despite the fall in the annual headline inflation figure, the quarterly rise in the cost of rent, international holiday travel and accommodation, other financial services and new owner-occupier dwelling continued to rise (at 2.5%, 6.2%, 2.5% and 1% respectively). Interestingly, the financial services increase was primarily due to real estate transfer fees and charges, proving the housing market continues to face significant price pressures.
Perhaps this could be a reflection of what has been coined by some as the recent “panic selling of pandemic buyers” – with data released in June showing 5% of all loss-making sales in the past twelve months were from buyers who bought the home less than one year ago.
The relationship between rising rents and inflation
A tight housing market however, is not just increasing costs for owner occupiers, that Ms Marquarndt made clear on Wednesday. “Rents recorded the strongest quarterly rise since 1988,” she explained, “reflecting low vacancy rates amid a tight rental market” as “rental price growth for flats continued to outpace the growth for houses.”
The issue of rising rents is a difficult one for Australia’s central bank to handle, as the non-discretionary expense has been said to be feeding into wider inflationary pressures, and not just in the way many would assume (where rents rise as a result of landlords passing on interest rate hikes to borrowers). According to Eliza Owen, Head of Research at CoreLogic, there are two ways that rental costs influence inflation.”For one, rents are an input in measuring inflation,” she said, “when rents rise, inflation can rise, and this prompts the RBA to lift interest rates.”
“Secondly, interest rates can impact rent,” she continued, “higher interest rates mean investment property becomes less attractive, which could slow the delivery of new rental stock coming to market, and this could push rents higher.”
RBA Governor Philip Lowe made it clear in his speech to the Standing Committee on Economics back in February, that he agrees, particularly with the second point made by Owen. “All our work suggests that it’s the vacancy rate that explains most of the movements in rents,” he said, “that’s what the underlying economics is.”
“The critical issue here is the lack of rental accommodation. That’s what’s driving higher rents, not higher interest rates,” he continued. “Higher interest rates are the explanation, but the underlying reason is that at the moment there’s strong demand for rental accommodation and there’s not enough rental accommodation on the market.”
The issue is supply, supply, supply.
As Lowe mentioned previously, the main issue with inflation is supply, supply, supply. Demand in the Australian economy is outpacing the supply in the housing market, and this is not just in the rental space.
Despite the 400bps increase to the cash rate since May 2022, Domain data shows Sydney house prices jumped 5.3% in the June quarter, the “sharpest quarterly increase since late 2021.”
These supply issues are being further exacerbated by a significant increase in migration, which is occurring at double the average rate of the decade prior to the Covid pandemic. Yet to blame migration solely is a narrow-minded view. There has also been a shift in household composition, with smaller household sizes causing a significant impact.
According to the RBA, the measure of Average Household Size (AHS) dropped from 2.55 people per household in late 2020, to 2.48 people per household in September 2022, equating to 120,000 additional households.
“Fixed income is incredibly attractive right now”
With uncertainty in the property market, leaders in the space are seeking alternative investments. Speaking at the Fixed Income Symposium in the US this week, Celso Munoz from Fidelity Investments was backing fixed income. “Fixed income is incredibly attractive right now,” he said, “right now, they’re offering 8% to 10% of yield, which is a lot of income.” When asked about the risks of default upticks, he replied, “there’s more than enough yield to absorb these defaults.”
Fixed income, which has been having its day in the sun since central banks began their aggressive hiking cycles, could be the smarter investment option in this strange new world of slow growth, high inflation and rising rates.
If you managed to build up a savings buffer during the ‘era of free money’ now might be the time to put those savings to work. The Australian Bond Exchange is currently offering retail investors the opportunity to invest in fixed income with minimum investment amounts as low as $10,000.
From Tier 2 Bank Hybrid Securities, to bond-linked securities, to market-linked products tied to companies including Rakuten Group, Marks & Spencer and Rolls Royce, locking in high yields now could help you navigate inflationary pressures.
RBA announces new 2024 meeting dates as they prepare for the next rate decision
This week was a busy one, with the RBA also releasing key information regarding the new central bank meeting dates for cash rate decisions come 2024. As new Governor Michelle Bullock takes over from the Governor of seven years on September 18, Australians will be watching to see if she makes the same mistakes as her predecessor.
The new RBA meeting timeline, which includes eight two-day monetary policy meetings per year, will see the board hold fewer meetings, and provide more in depth explanations of their reasoning behind the decisions.
The new meeting dates, outlined below, will begin the afternoon of the first day, and conclude in the morning of the second, with the rate decision announced at 2.30pm on the second day. The RBA Governor will then host a Press Conference at 3.30pm on the second day, with the statement released (as per usual) two weeks after the decision has been made.
2024 Reserve Bank Board meetings
- 5–6 February
- 18–19 March
- 6–7 May
- 17–18 June
- 5–6 August
- 23–24 September
- 4–5 November
- 9–10 December
Will the RBA follow the Fed with another hike?
Currently the EU, UK and U.S. central banks all employ the eight meetings a year structure, meaning this change will put the Australian central bank more in line with its western counterparts. This shift toward the preferred central bank structure of the U.S. however, may not be the only leaf Aussies are taking out of the Americans central banking book. On Tuesday, the markets were pricing in a 61% chance of another RBA rate hike next week, but when CPI data was released (that showed inflation was easing) this dropped to a one in four chance.
However, with the International Monetary Fund (IMF) urging central bankers to keep rates high and end household energy subsidies, and the U.S. Federal Reserve proving on Wednesday that despite a 3% inflation rate they are still determined to reach the 2% target by continuing their hiking cycle, perhaps the markets will once again be shocked by the RBA’s decision.
Or, perhaps, Philip Lowe will take the fall for his replacement Michelle Bullock, by hiking rates before he finishes up in September, to ensure that she gets the honeymoon period of pauses and rate cuts that some economists are forecasting.
What’s coming up next week:
- Next Tuesday 1 August at 2.30pm the RBA will announce their decision as to whether they will hike or pause the cash rate, currently sitting at 4.1%pa.
- Next Thursday 3 August, the UK will also release their cash rate decision here, as the Bank of England decides whether to increase from the current rate of 5%pa to battle a sticky inflation rate of 7.9%pa in the year to June.
- Next Friday 4 August the US Bureau of Labour Statistics will release the monthly unemployment rate “Employment Situation” here, which is currently sitting at 3.6%pa.
*Data accurate as at 28.07.2023
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