The Reserve Bank of Australia (RBA) will be gathering again next week to decide on the cash rate.
At the last meeting, the central bank surprised the market with a smaller than expected rate hike.
The market was forecasting a 0.5% increase, but the RBA lifted rates by 0.25% to 2.60%.
How big will the RBA's rate hike be in November?
According to the latest cash rate futures, the market is sitting on the fence with this meeting, pricing in only a 51% probability of a 0.5% increase to 3.10%. It appears to believe a smaller 0.25% increase to 2.85% is the more likely route that the central bank will take.
However, the economics team at banking giant Westpac Banking Corp (ASX: WBC) don't agree with this view and are predicting a 0.5% increase.
According to its latest weekly economic report, Westpac's chief economist, Bill Evans, believes that the latest quarterly inflation reading was a major surprise and will force the RBA to act. He said:
The September quarter inflation report has come as such a major surprise that we think the Reserve Bank Board will decide to raise the cash rate by 50bps at the next Board meeting on November 1.
The quarterly CPI print was an increase of 1.8% for the trimmed mean (the accepted measure for underlying inflation) well above market expectations of 1.5%. Annual trimmed mean inflation lifted to 6.1%yr. This is the highest quarterly and annual increase in underlying inflation since the ABS began producing estimates in 2002. Historical estimates compiled by the RBA show the quarterly rise is the biggest since 1988.
But why raise rates?
Evans believes the RBA needs to take strong action now before things get out of control. He explained:
During this period of rising inflation we have been most concerned about a strong inflationary psychology becoming entrenched in the Australian psyche. As this develops, businesses become more confident that they can raise their prices; consumers become more accepting of such action and see significant wage increases, in the context of tight labour markets, as necessary to compensate, sustaining the whole inflation process.
Evidence from the survey that pricing power is becoming widespread across expenditure items should be of considerable concern to an inflation–targeting central bank. The Budget papers have raised the prospect of a 50%+ increase in electricity prices over 2022 and 2023. This means inflation overall will remain more elevated and poses further pressures on inflation psychology. The best way for the central bank to break this nexus is to adopt strong rhetoric and strong action.
