ECB hikes rates, economists expect RBA might be next

The European Central Bank (ECB) has raised the interest rates on the deposit facility by 25 basis points to 2.5%, in a bid to stabilise inflation at its 2% target in the medium term, as conflicts in the Middle East continue to generate inflation pressures.

This is the second rate hike from the ECB since the start of the Iran war.

"The unanimous decision came on the back of the ECB raising its inflation forecasts, with inflation now expected to remain above target through 2027," Principal Asset Management market strategist Christian Floro said.

"While ECB President Christine Lagarde did not provide any forward guidance, instead emphasising the need to keep all policy options open given the fluid nature of the conflict and its potential spillovers, the forecast revisions alongside the continued rise in energy prices imply that further tightening is likely."

Inflation continues to remain elevated in Australia as well.

"The economy in Australia in many ways is doing quite well. We've got growth roughly at trend. We have unemployment near historic lows, employment growth driven by the market sector, and real household incomes are growing pretty strongly. There's a lot to like about the Australian economy, but we have one big problem and that's inflation," Reserve Bank of Australia (RBA) deputy governor Andrew Hauser told the ABC this week.

"Inflation is too high, and that's why we raise interest rates three times at the beginning of this year. And the question now, frankly, for us is have we done enough or is more needed?"

On September 8, the market expected a 66% chance of a rate hike at the next meeting. The expectation has now risen, with 72% of the market now expecting a rate hike by 25 basis points to 4.6%.

Hauser said the RBA is concerned about three risks that might push inflation further up: the Middle East and the ongoing crisis, unexpected global boom driven by artificial intelligence (AI) and the weakness of the supply potential of the Australian economy.

Commenting on Hauser's rhetoric, CreditorWatch consulting chief economist Ivan Colhoun said the bottom line is the RBA will recommend a tightening to the board at the next meeting and that expects that recommendation to be accepted.

"Like assistant governor Hunter's fireside chat earlier in the day, the message was extremely hawkish and almost exclusively focused on inflation," Colhoun said.

"The question is whether even more near-term tightening might be on the cards. I have been discounting this as I don't think the economy is quite that strong, but there is the possibility that the Board has got to the end of its tether on above-target inflation. That said, I always caution myself that the RBA always sounds most hawkish when it's just tightened and most dovish when it has just eased."

Prior to Hauser's comments, Westpac revised its RBA call, reinstating a 25 basis points November rate hike.

"Domestic demand is proving more resilient than we had anticipated, buoyed by stronger household incomes and a large pipeline of data centre and renewable energy investment, limiting the pace of disinflation," Westpac said.

"Markets are pricing in a circa 80% chance of a September rate hike, but we believe the board will prefer to wait for confirmation from the full quarterly inflation data and its revised forecasts."