The RBA left its cash rate unchanged at 1.50% at its March policy meeting and the accompanying commentary is essentially unchanged – still low wages growth and inflation threat; the economy is slowly picking up pace; uncertainty surrounding the strength of spending in the heavily indebted and income constrained household sector. There is little pressure on the RBA to hike the cash rate in the near term and it is probably going to wait until it sees more signs that wages growth is lifting before it starts to hike rates. It is worth keeping in mind that the first signs of higher wages growth are starting to show. The more than 3% per year over the next three years pay deal agreed between the NSW Government and train drivers breaks the longstanding 2% wages growth ceiling in public sector deals in the state and higher pay deals are likely to follow. The tightness of the labour market in certain sectors is also starting to foster higher pay deals. Our view is that higher wages growth will probably develop quite fast and that by August the RBA will be reviewing higher forecasts of wages growth and inflation in 2019. We expect an RBA rate hike in August followed by a second hike in November. We also expect three or four rate hikes in 2019 taking the cash close to 3.00% by the end of 2019.
One recent complication is the tit-for-tat import tariff skirmish that has developed between the United States and China. If this skirmish broadens in to a broader international trade war the main consequences are likely to be softer global economic growth than would otherwise be the case, but alongside higher inflation because of the higher cost of imports. A trade war makes it more likely that the US Fed will tighten monetary policy more aggressively and the same applies to the likelihood and extent of RBA rate hikes. A trade war also compromises growth in business profits and will increase significantly the cost of offshore funding. Credit ratings will almost certainly come under pressure to widen in these circumstances.
Predicting how yield curves will alter has become more difficult. The fear of a wider trade war and its negative consequences for global and Australian growth is providing brief cause for longer term bond yields to rally and by more than shorter-term bond yields tied closer to central bank official interest rates. As the inflationary consequences of a broader trade war become recognised more widely it is possible/likely that longer term bond yields will suffer periods of sell-off. The movement in the yield curve could start by flattening but with periods beyond of steepening and renewed flattening. Over time, the curve may become entirely flat and perhaps even inverse in shape as the risk increases of a trade war driving some countries towards recession.