The S&P/ASX 200 Index (ASX: XJO) has proven to be quite sensitive not only to actual rate moves from the Reserve Bank of Australia (RBA) but also to any shift in investor expectations.
On 6 June the RBA increased interest rates by 0.25%, taking Australia's official cash rate to 4.1%.
The ASX 200 fell 0.7% in the minutes following the announcement, the central bank's 12th rate hike since its first increase on 3 May 2022.
Odds of another RBA rate hike in July increased a few days after that announcement. This came after the ABS reported on sluggish Aussie GDP growth and signs of spiralling wages over the March quarter.
That data is unlikely to appease RBA governor Philip Lowe, who earlier stated, "The best way to achieve a moderation in growth in unit labour costs is through stronger productivity growth."
But things took a turn for the dovish yesterday, 28 June, thanks to a lower-than-expected May inflation print.
Consensus forecasts were for annual inflation to come in at 6.1%. However, the monthly Consumer Price Index (CPI) indicator rose only 5.6% in the 12 months to May 2023, down from 6.8% a month ago.
And investors sent the ASX 200 soaring 0.7% immediately following the release of the data.
But that might be premature.
Underlying inflation, which excludes items with volatile price changes, is proving to be a good bit stickier.
"When excluding these volatile items, the decline in inflation is more modest," ABS head of prices statistics Michelle Marquardt said.
Which bring us back to…
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Should ASX 200 investors expect another rate increase in July?
The futures market has been paring down expectations of a July rate increase.
Following the subdued inflation print, the futures market is pricing in 16% odds of a rate hike next Tuesday. That's down from 23% the day before and down from 51% on 19 June.
Clearly expectations for the interest rate burden on ASX 200 shares remain fluid.
So, what are the experts forecasting?
Odds of July pause up, but another hike or two in 2023 is likely
Josh Gilbert, market analyst at eToro, told The Motley Fool, "This was the stupendous print that the RBA and investors were looking for. Australian monthly inflation fell significantly."
Gilbert added:
Philip Lowe has reiterated that the RBA is data-dependent, and this latest reading reflects the economic criteria that Lowe indicated was required for the RBA to consider changing tack…
Markets are already pricing in a peak cash rate of 4.6% so the good news is that we're unlikely to see rates move above that level unless inflation and other data points stall significantly in the months ahead.
AMP deputy chief economist Diana Mousina forecasts the ASX 200 will enjoy a July pause from the central bank, but she still foresees one or two more hikes this year.
According to Mousina (quoted by the Australian Financial Review):
There are clear signs that inflation is slowing and there will be further downside in coming months … however, clearly the pace of inflation is too high and well above the RBA's target 2% to 3% target band.
JP Morgan economist Tom Kennedy also thinks the muted inflation print will give the RBA room to pause in July, before increasing rates on 1 August.
Also in the July pause camp are the economists at HSBC and CBA.
But not everyone agrees.
According to Capital Economics head of Asia-Pacific Marcel Thieliant (quoted by the AFR):
As things stand, headline inflation is on track to reach the RBA's May forecast of 6.3% in the June quarter. But with the labour market still very tight, unit labour cost growth surging and the housing market bouncing back with a vengeance, we suspect that the bank will press ahead with another rate hike next week.
Joining Thieliant in predicting that ASX 200 investors should expect the RBA to boost rates next week are the economists from NAB, St George and ANZ.
As for this economist, I'd prepare for that increasingly unexpected rate increase next Tuesday.
Don't forget Lowe's recent warning.
"If high inflation were to become entrenched in people's expectations, it would be very costly to reduce later, involving even higher interest rates and a larger rise in unemployment," he said.
Either way, we'll know the answer simply by watching how the ASX 200 reacts next Tuesday at 2:30pm AEST.
