How high could interest rates peak?

Commentators believe interest rates could rise further in the future, according to Schroders chief executive Simon Doyle, even as the RBA opts to pause for December.

Yesterday (5 December), the RBA voted to hold interest rates at 4.35 per cent, which was governor Michele Bullock’s third monetary policy meeting since she took over the governor role from Philip Lowe in September.

Stuart Dear, head of fixed income at Schroders, said rates are close to their peak in the US and Europe, but could have further to go in Australia. The risk of a mild recession is high and inflation is expected to moderate but remain at uncomfortable levels, he said.

“Rates are very close to their peak in the main economies as growth has slowed and inflation has slowed. It looks like we are done in those countries, especially in the US and Europe. In Australia, we have tightened more cautiously and are 6–12 months behind the US; there is a good chance we will still tighten one more time.

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“This is a good time to go into fixed income and we have been doing that over the last few months to lock in high yields, especially investing in the investment grade space. We don’t want to take too much risk by going into lower quality bonds.

“The US and Europe have about 100 bps of rate cuts priced in for next year, that’s possible but I think Australia has lots of uncertainty still around.”

Doyle added: “Cash rates have gone from 0 per cent to 4.35 per cent, but it wasn’t long ago that rates were at 4.75 per cent, and that was a low. So, you do have to wonder if you take a three- or four-year view, whether there’s a higher peak in rates ahead.”  

To take advantage of the interest rate environment, the firm is overweight in investment grade credit, especially in Australia, overweight in inflation linked bonds and moderately overweight in duration risk. 

Referencing the company’s exposure to investment grade credit, Dear said: “This is a key way to access income from high-quality assets at a reasonable price and an attractive way to build inflation resilience via sectoral exposure to infrastructure, utilities etc. 

“We also like Australian bank subdebt, which sits in a sweet spot for return versus risk in the capital structure given the strong Australian banking sector, but are cautious on riskier global credit.”

Also commenting on the potential for further rate rises, AMP chief economist Shane Oliver, agreed there are more hikes on the horizon.

"Given its hawkish bias our view is that the risk of another rate hike remains high at around 40 per cent and it if occurs it will be at the February meeting.

"Yet continuing to raise interest rates will only add to the already very high risk of recession, particularly given the uncertainty around the long and variable lags with which rate hikes impact the economy meaning there is a big impact yet to fully show up. As a result, the economy is likely to slow further into next year which along with supply chain improvements is likely to push headline inflation down to three point something earlier than the RBA is allowing."

Paul Bloxham, chief economist of Australia, New Zealand and global commodities at HSBC, said: "Our central case is that the cash rate will now be held steady at 4.35 per cent for some time. However, given that inflation is set to fall only slowly and therefore remain above target for some time yet, we also see cuts as unlikely anytime soon.

"Having hiked by less than most of the major central banks, the RBA may be one of the last central banks to be able to cut. HSBC's house view is that the US Fed cuts from Q3 2024, the ECB cuts from Q4 2024 and the Bank of England cuts from Q1 2025. We expect the RBA to back of the pack, with our central case that the RBA's cash rate is on hold at 4.35% through 2024, with cuts beginning in Q1 2025."