The next RBA rate move will be down, says Westpac

This month, RBA governor Michele Bullock expressed concern that the escalating conflict in the Middle East could keep oil prices and inflation higher for longer, causing people to adjust their expectations.

She said the “million-dollar question” facing the bank was how people’s inflation expectations responded to higher prices for common items such as petrol, food and accommodation.

Vote of confidence

At present, consumer surveys indicate that the respondents expect prices to moderate in the next few years, which is a vote of confidence in the RBA’s ability to steer inflation back to its target range of 2 per cent to 3 per cent by late 2025.

But Bullock warned that the central bank had to be careful to ensure that persistent price increases did not cause inflationary expectations to become entrenched, making it harder to bring inflation under control.

“We have to alert people to the fact that if inflation continues to be higher than expected, and the risks are on the upside, then we’re going to have to respond with monetary policy,” she said.

But the Westpac economists appear much more sanguine. They expect the RBA to start cutting interest rates in the second half of next year, tipping a fall in the official cash rate to 3.85 per cent by September and 3.6 per cent by December next year.

They predict that by June 2025, the official cash rate will have dropped to 3.1 per cent.

The bank’s economics team also expects the US Federal Reserve – which has a target range of 5.25 per cent to 5.5 per cent for its official rate – to start cutting interest rates early next year. The mid-point of the Fed’s target range is expected to fall from 5.375 per cent at present to 4.375 per cent by December 2025.

The economists say the US 10-year bond yield – regarded as a global benchmark – is likely to drop from 4.9 per cent at present to 4.6 per cent by the end of this year.

According to the Red Book, “consumer expectations for inflation eased slightly over the three months to October but expectations for wages growth ticked up a touch”.

“Neither will be posing great concerns for the Reserve Bank with inflation expectations heading in the right direction and wage expectations still looking relatively benign.”

It notes that consumer sentiment remains deeply sombre, and people are finding little comfort either from the pause in the RBA’s interest rate tightening cycle, or from declining inflation.

“The constant cash-flow hits from interest rate rises may have stopped for many but consumers remain on high alert for further rate rises,” it says.

Risk aversion at record high

At the same time, risk aversion – particularly for middle-income, middle-aged and mortgage-belt consumers – remains close to record highs.

“All else being equal, these high levels of aversion could be expected to see consumers act more conservatively with their finances, favouring saving over spending and aiming to keep debt levels low rather than increase leverage.”

The Red Book highlights the important role that large savings buffers built up during the coronavirus pandemic have played in supporting consumer spending, despite the slump in consumer sentiment.

“Based on historical relationships, current reads in sentiment could have delivered a very large contraction in per capita spending, in the order of 5 percentage points.

“Instead, while spending has been weak, it has been trimmed rather than slashed, declining by closer to 0.5 percentage points in per person terms over the cycle to date.”

Westpac is credited with having pulled off a major coup in persuading Ellis, widely acknowledged as one of the country’s most talented economists, to quit the RBA after more than three decades and to take over from Bill Evans as the bank’s chief economist.