© Westpac

Westpac economists have raised their forecast for the Reserve Bank of Australia (RBA) cash rate to 4.1% after the latter adopted a more hawkish tone in its February monetary policy statement owing to concerns about a divergence between inflation at home and abroad.

Australian inflation rose in December when in most other advanced economies it fell, leading the RBA to worry that it may need to go further in the short-term so as to avoid having to do even more at greater cost to the economy in subsequent months.

The bank had been hopeful that November's decline in the consumer price index inflation rate from 7.3% to 6.9% would be sustained but in January it rebounded to 7.1% despite price pressures having moderated in many other places.

"Since October we have consistently held the view that the cash rate would peak in May at 3.85%. We still see the date of the peak as May 2023 but now see that peak as slightly higher," says Bill Evans, chief economist at Westpac.

"We have lifted our forecast terminal RBA cash rate from 3.85% to 4.1%," Evans writes in a Friday forecast review.

Above: Changes in market-implied expectations for RBA cash rate between selected date. Source: Goldman Sachs Marquee. Click image for closer inspection.

The RBA lifted its cash rate to 3.35% in February, making for a ninth increase since May 2022 and the bank's strongest tightening cycle for a lengthy period, before warning that further increases would likely be necessary in the months ahead.

"The Minutes highlight insights into the Board's more hawkish approach since the release of the December quarter Inflation Report, including an interesting comparison with other central banks," Evans writes in reference to minutes of the February meeting released last week.

"In discussing the option of 50 basis points the Board emphasised its concerns about persistent high inflation," Evans adds.

February's updated forecasts had anticipated that it would likely take several years for inflation to return to within the 2% to 3% target band even if the RBA lifts its cash rate to the 3.75% that was tipped earlier this month as the likely 'terminal rate.'

Interest rate derivative markets, however, have leapfrogged the new forecasts already and have since priced in a peak of 4.27% for later this year.

That implies risk of up to another 100 basis points of increases in the cash rate over the coming months.

Above: AUD/USD shown at daily intervals with selected moving averages and alongside AUD/GBP. Click image for closer inspection.