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Anna Hong: What’s next for rates after RBA loses patience

What’s next for rates now the Reserve Bank has lost its patience? Assistant portfolio manager ANNA HONG explains

THE Reserve Bank this week took a small step towards a June rate hike.

In February and March, Governor Phil Lowe’s monthly statements referred to the board’s willingness to be “patient” as it “monitors how the various factors affecting inflation in Australia evolve”.

This month the word “patient” was conspicuously absent — though the omission was anticipated by the market.

“Over coming months, important additional evidence will be available to the board on both inflation and the evolution of labour costs,” Dr Lowe said.

“The board will assess this and other incoming information as its sets policy to support full employment in Australia and inflation outcomes consistent with the target.”

Some are expecting a hike in May. But the reference in this month’s statement to upcoming inflation data on April 27 and wages data on May 18 suggests a pre-election rate rise in May is unlikely.

It’s more likely next month’s statement will feature a further change of language that paves the way for a rate hike in June.

Only twice in Australian history has the RBA changed interest rates during an election — the first was a rate hike, the second a rate cut.

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Pendal’s Income and Fixed Interest funds

Both times there was a change in government.

Dr Lowe declined to cut rates in May 2019 — just 11 days before the last federal election — even though unemployment was drifting higher.

We expect this time will be no different.

The first election rate change occurred in November 2007.

Back then RBA Governor Glenn Stevens decided to raise interest rates 17 days out from the election to manage rising inflation.

This action — and two more rate hikes in early 2008 — helped Australian inflation peak in September 2008. Though the global financial crisis may have played a bigger role.

There are similarities between our current state and November 2007.

But inflation is now more supply-side led. And the RBA has this time chosen to remain dovish for longer, continuing to leave cash rates at 0.1%.

Despite that, the banks are already repricing for the future.

Advertised fixed rates have risen more than 60% from an average of 2.14% to 3.48%, according to APRA and RBA data.

In addition, the serviceability buffer was raised from 2.5% to 3% in the new home loan assessments.

This has led to Sydney and Melbourne house prices cooling off, signalling that a phase of high capital gains may be behind us.

With a surge in fixed-rate borrowing well and truly behind us, variable rate rises are not far away.

The market is predicting more than 3% of rate hikes in the next few years. If that’s correct it will be interesting to see how mortgage holders cope.

Household deposits continue to rise — up $255 billion since the pandemic — indicating Australian households have a war chest to cushion the blow.

But that’s not necessarily good news.

Delayed action in tackling inflation may result in a long, drawn-out battle to curb price rises fuelled by supply chain issues.

Will the supply chain issues ease sufficiently to prevent a protracted rate hike cycle?

The RBA will be cautiously watching this dynamic.

Looking ahead, we have the RBA Financial Stability Review coming up, in addition to the NAB Business Conditions and CBA Household Spending Intentions.

We are keen to understand the RBA’s assessment of the impending mortgage stress and its concerns around the ability of the wider economy to withstand rate rises.

NAB Business Conditions and CBA Household Spending Intentions will provide a good gauge on forward-looking business and consumer confidence.

If those indicators remain elevated we may see costs of living get another leg up.

Portfolio implications

For many investors, the current dilemma in portfolio decisions relates to the relative importance of the geopolitical instability in Europe versus the inflation trajectory.

With Australian Government 10-year bonds appearing to have found support in the 2.8% to 3% range, a balanced portfolio can increase its defensiveness knowing that most of the inflation concerns are already priced in.

Furthermore, 10-year real yields are now positive (more than 0.3%).

That carry can provide good protection for investors.

About Anna Hong and Pendal’s Income and Fixed Interest team

Anna Hong is an assistant portfolio manager with Pendal’s Income and Fixed Interest team.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s fixed interest strategies here

About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at April 7, 2022.

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