RBA Hikes Interest Rates to Contain Inflationary Pressures

The Reserve Bank of Australia (RBA) is expected to raise interest rates by 25 basis points on September 29th, bringing the cash rate to 4.6%. This decision reflects a strong economy with multiple indicators pointing to inflation pressures.

Labour market conditions remain tight, with second-quarter GDP growth exceeding expectations and recent inflation readings stronger than anticipated. While the housing market has shown signs of cooling, the RBA is expected to emphasize that inflation risks remain tilted to the upside, requiring further vigilance to ensure price pressures return sustainably to target.

Core inflation has proven stickier than anticipated, with trimmed mean inflation likely holding at 3.6% year-on-year in August for a third consecutive month. This suggests core inflation accelerated in Q3 rather than eased, challenging the RBA's expectation that trimmed mean inflation would slow to 3.3% by year-end.

The RBA estimates that a 10% increase in fuel prices could add more than 0.3ppt to headline inflation over one to two quarters, with indirect effects from production and transport costs contributing a further 0.2-0.25ppt. Labour demand remains strong, with full-time employment growth strengthening in both July and August.

The Australian dollar has had a rough week due to poor risk sentiment and the global bond selloff, but our short-term fair value model indicates AUD/USD is now undervalued beyond the 1.5 standard deviation band. We expect an RBA hike to help the AUD weather turmoil and revise our year-end target for AUD/USD from 0.73 to 0.72.