There's been a dramatic shift in market expectations for the next RBA rate hike

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  • Bullish sentiment around the next RBA rate hike has reversed course.
  • Data from Capital Economics shows the change has been seen among both analysts and financial markets.
  • Economist Kate Hickie said the RBA’s more cautious stance could also be attributed to the pending fallout from the banking Royal Commission.

Earlier this month, the RBA kept interest rates on hold for a record 19th consecutive meeting.

The central bank said evidence of the drivers for higher interest rates — wage growth followed by higher inflation — just hasn’t been strong enough to justify a prospective rate rise.

Financial stability concerns about the housing market have prevented a corresponding decrease, keeping the RBA stuck in policy inertia.

But research from Capital Economics shows that until recently, market analysts were bullish about the prospects of higher rates.

“There has been a remarkable turnaround in the interest rate expectations of the financial markets and most analysts over the past six months or so,” CE economist Kate Hickie said.

This chart tells the story, showing how the consensus view — for another rate hike in 2018 — was rejected in February:

“As recently as last October, the financial markets were pricing in almost two 0.25% rate hikes by the end of this year,” Hickie said.

“And throughout last year the consensus amongst analysts was for at least one 0.25% hike, with analysts at most of the big domestic banks forecasting two 0.25% hikes.”

NAB was the last of the big four banks to change its tune. Chief economist Alan Oster said last week that the bank no longer sees a rate increase in 2018.

The median forecasts among analysts is now for rates to stay on hold at 1.5% this year, while financial markets are pricing in just a 14% chance of a 2018 rate hike.

Hickie attributed part of the shift in sentiment to recent data related to the consumption outlook. Continually soft wage growth figures were accompanied by stagnating retail sales growth in March.

In addition, recent announcements by the RBA itself have made it clear that Australia’s central bank is in no rush to raise interest rates.

But Hickie highlighted that some of the RBA’s recent rhetoric may have been influenced by the pending fallout from the ongoing banking royal commission.

Earlier this month, the minutes from the RBA’s May meeting showed that one of its aims is to be a source of “stability and confidence”.

While some analysts speculated that such an ideal also formed the basis for the bank’s overly-optimistic economic growth projections — thereby raising the risk of a credibility problem — Hickie said the royal commission could also be a factor.

Referring to stability and confidence “could be interpreted as a signal that the RBA is not about to rock the boat and raise interest rates while domestic banks are under scrutiny from the Royal Commission”, Hickie said.

“So even if the economy evolves in line with the RBA’s forecasts, which would be much stronger than we or the consensus expects, the uncertain outlook for credit conditions in the light of the Royal Commission would probably mean that it refrains from raising rates anyway.”

Capital Economics is sticking to its forecast that the RBA will stay on hold until the second half of next year.

But if there’s a significant tightening in credit conditions — which analysts at UBS highlighted as a key risk last week — the timeframe for rate hikes could extend into 2020.

Hickie said such a scenario would put longer-term downside pressure on the Australian dollar.

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