Morgan Stanley tips RBA will hold interest rates before cutting them as oil shock, war hit Australian economy
The market is underestimating a brewing economic downturn, the investment bank has warned.
The wrecking ball impact on the Australian economy from the Middle East conflict means the Reserve Bank will decline to lift rates again in 2026 before moving to an easing cycle next year, according to economists at Morgan Stanley.
On Tuesday the investment bank warned the market is underestimating a brewing economic downturn in Australia as house and equity prices fall.
While consumer confidence plunged to a 53-year low in March as evidence mounts that households are being swamped by higher interest rates and petrol prices.
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Their cause is supported by last month’s decision being lineball, with a 5-4 vote in favour of a hike. Some economists believe this means a hold is likely for May.
“Our base case remains the RBA stays on hold from here, given we expect evidence of demand weakness to be more evident going into the May meeting,” said Morgan Stanley. “This is particularly the case given the March meeting was only a narrow vote to hike (5-4) with the dissenters concerned on growth risks from the global disruption — concerns that we expect will only build at the May meeting.”
Next two weeks crucial in fast moving conflict
As of April 7, interest rate futures traders placed a 64 per cent chances of a rate increase at the central bank’s May 5 meeting, down from expectations as high as 72 per cent on March 20.
The market also expects another 67 basis points of rate increases in 2026, although Morgan Stanley said the Middle East war and energy shock is now so fast moving that the next couple of weeks could see rate rise expectations drastically reduced.
“Inflation upside will be paired with growth downside — and we expect the latter will emerge faster than investors and policymakers expect with some evidence already emerging,” said Morgan Stanley. “This bodes poorly for the near-term cyclical backdrop, particularly for the household.”
Morgan Stanley now expects Australian inflation to peak at 5 per cent in the June quarter of 2026 when accounting for petrol price subsidies that will artificially lower the headline number.
It also warned the spiralling of the Middle East conflict into a regional war that has destroyed energy production infrastructure across the Gulf states means energy prices will stay higher-for-longer even if the Strait of Hormuz is reopened to shipping in April.
As a result it said to prepare for oil prices that average $US110 a barrel over the three months to June 30 in a price shock that will add to cost of living pressures across Australia.
“A downside scenario for Australia would involve more extended supply disruptions that sees lower fuel volume availability in key products, especially diesel,” the investment bank said. “This would likely require some industrial activity curtailment that would see a much faster and sharper growth downside scenario emerge.”
The investment bank thinks the darkening outlook for Australian households means the RBA will be forced to cut rates to just above 3.5 per cent by the end of 2027.
Market still calls for hikes
Other economists and investment banks still believe the RBA will lift interest rates at least 50 basis points, or two more times, to 4.6 per cent this year in a bid to avoid a nightmare scenario of high inflation and soaring unemployment.
“The RBA will need to increase official interest rates to stop inflation expectations from un-anchoring,” said Citi Australia’s chief economist Josh Williamson. “We still believe the labour market is tight and unlikely to prevent the RBA from hiking rates further. Inflation pressures will likely remain at the forefront of RBA’s concerns, which the oil shock threatens to compound.”
The S&P/ASX 200 also pared some early gains on Tuesday on news that Iran had attacked Saudi Arabia’s petrochemical production plants in Jubail. It finished the day at 8728 points and is down 5.2 per cent since it closed at 9198 points on February 27, before the Middle East war’s eruption.
House prices in Sydney and Melbourne also declined in March as auction clearance rates tumbled, with economists saying the uncertain trajectory of interest rates over 2026 will be a key swing factor in the direction of the market.
