RBA to hike 25bps

AUD: RBA to demonstrate its resolve?

The recent decision made by the Living Wage Commission (LWC) to increase the minimum wage by 5.75% starting from July 1st, following a 5.2% increase in 2022, has made the RBA decision today a difficult one.

This decision has undoubtedly solidified the likelihood of at least one more 25 basis point (bp) interest rate hike.

The consecutive rise in the minimum wage above the target demonstrates a lack of confidence by the Commission in the RBA's ability to bring inflation back within the 2-3% target range.

It is also important to note that this wage increase coincides with strong migration supporting underlying demand and inflation, as well as an upcoming significant increase in electricity prices on July 1st, aligning with the surge in global energy prices. Additionally, the April Consumer Price Index (CPI) revealed a reacceleration in inflation to 6.7% year-on-year (YoY), although this reading was influenced by the base effect of the government's reduction in the fuel price levy in April 2022.

There is a substantial risk of inflation expectations becoming untethered from the RBA's inflation target, potentially leading to a wage-price spiral. This risk cannot be overlooked by the RBA. Despite the weakening data on Chinese and Australian consumption and the labour market, the central bank will have to raise rates by 25bp today to demonstrate its determination to bring inflation back within the target range. If the RBA proceeds with a rate hike today, it may be perceived as being against wage growth, further jeopardizing the re-appointment of RBA Governor Philip Lowe when his term ends in September.

Nevertheless, Lowe's re-appointment is already unlikely, and to his credit, he has consistently emphasized that he is not against wage growth per se, but rather against wage growth not accompanied by corresponding increases in productivity. Lowe has stated that pay rises of up to 4% could be sustained and aligned with the inflation target if productivity growth were to reach its long-term average of 1.0-1.5%. However, since productivity growth is currently close to zero, the RBA views the 5.75% increase in the minimum wage as exerting additional upward pressure on inflation. Most economists surveyed expect the RBA to maintain the current interest rate, while the market reflects a roughly one-in-three chance of a 25bp rate hike. Therefore, a rate increase would come as a surprise and likely strengthen the Australian Dollar (AUD). Looking ahead, the market has already priced in another 25bp rate hike by August, with a one-in-three chance of an additional 50bp increase later in the year. Even if the RBA decides to keep rates unchanged today, there is a risk that Lowe's decision statement and subsequent speech on Wednesday may adopt a more hawkish tone in order to curb inflation expectations, causing the market to move closer to fully pricing in the potential for 50bp worth of rate hikes later this year.

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