Cliff Notes: Facing Uncertainty
WestpacThe RBA Monetary Policy Board decided to raise the cash rate by 25bps to 3.85% this week, in line with economist and market expectations. Justifying the decision, the Board stated that inflation had "picked up materially" against a backdrop of "greater momentum in demand".
Key insights from the week that was.
The RBA Monetary Policy Board decided to raise the cash rate by 25bps to 3.85% this week, in line with economist and market expectations. Justifying the decision, the Board stated that inflation had "picked up materially" against a backdrop of "greater momentum in demand". Capacity pressures were seen as "unlikely to explain the majority of the recent increase [in inflation]", with "sector-specific demand and price pressures" which "may not persist" also evident. Together, these dynamics are contributing to elevated near-term inflation and a slower projected return to target, a clear source of discomfort for the Board.
In a video update midweek, Chief Economist Luci Ellis discussed the RBA's forecasts and the implications. A technical assumption of at least one more rate hike in 2026 together with a trimmed mean inflation forecast slightly above the mid-point at horizon's end (2.6%yr in Jun-28) suggests another rate hike is most probable. We have consequently incorporated a follow-up 25bp hike in May into our baseline view. Note though, this adjustment reinforces our view that rate cuts are likely to prove necessary down the track, most likely in November 2027 and February 2028, leaving the cash rate at 3.60%.
Higher actual and expected interest rates have softened house price growth at the margin. Stripping out the effect of 'thin' trading over summer, Cotality reports that national house price gains on a seasonally adjusted basis have moderated from 1.1% in Oct-Nov to 0.9% over Dec-Jan. Choppy monthly reads for dwelling approvals have meanwhile made assessing the strength of 'front-end' housing supply a challenge. 2025 was a more positive year for new supply, but it was still well below the Government's Housing Accord target. And headwinds are now stronger.
Before moving offshore, a final note on trade. The latest read on goods trade saw the surplus edge slightly higher to $3.4bn in December, supported by a modest gain in export earnings and a small decline in the import bill. The underlying dynamics point to a continued trend narrowing in the surplus, as global demand for commodity exports remains subdued and domestic recovery buoys consumer imports.
Offshore, there was plenty of central bank communications to parse.
The Bank of England kept rates steady at 3.75% in a 5-4 vote. Forward guidance points to a slower pace of easing in 2026 than 2025, with future decisions characterised as "a closer call". According to the minutes, there are presently three camps in the MPC. The most hawkish advocated to keep rates on hold, concerned inflation may hold above target. The middle camp, which contained Governor Bailey and Catherine Mann, noted that there is room for additional easing, but wanted further evidence that weaker activity will feed through to inflation. While the four doves that voted for a cut are already confident inflation will normalise.
The updated BoE forecasts certainly make the case for additional easing in 2026. Most notably, the inflation profile has been revised down significantly, now foreseeing a return to 2.0%yr by Q3 this year and a pace at year end 0.5ppts lower than expected three months ago. GDP growth is forecast to be 0.3ppt lower in Q4 2026 at 1.1%yr, and the unemployment rate 0.3ppts higher at 5.3%. We continue to anticipate a further Bank Rate cut in March followed by a final cut in Q2.
The European Central Bank meanwhile decided to hold rates steady in February. No new forecasts were released, and the central bank's forward guidance was largely unchanged, with the Governing Council set to "follow a data-dependant and meeting-by-meeting approach". In the press conference, President Lagarde highlighted external risks stemming from "a volatile global policy environment" and weaker sentiment in financial markets. On inflation, she stated that underlying inflationary pressures remain consistent with the 2% target, but also acknowledged that euro appreciation could push inflation below the desired level.
The stable outlook for inflation allowed President Lagarde to reiterate that the ECB is in a "good place", signalling that she, and likely most Governing Council members, currently see no reason to alter the existing policy stance. We hold a similar view, expecting policy to be unchanged through 2026, though we are mindful of the potential disinflationary impact of euro appreciation.
Finally to the US, the ISM PMIs for January pointed to improved conditions in the manufacturing sector and little change for services. The manufacturing PMI rose 4.7pts overall as the new orders component gained 9.7pts and employment was up 3.3pts. Note though that employment remains 4.8pts below the pre-COVID average, consistent with other labour market indicators which point to limited marginal labour demand. For services, conditions were unchanged overall despite a large decline in inventories and export orders. Employment also fell 1.4pts to be 6.3pts below its pre-COVID average.
Upstream prices pressures remain evident across the economy, the manufacturing prices component up 0.5pts in the month to be 3.2pts higher than its historic average and the services measure up 1.5pts, 10.4pts above the pre-COVID average. Tariffs, energy costs and capacity constraints across the economy are likely fuelling these pressures.
