Hopes of a Fed pivot are rising. Here's why the RBA's lower-than-expected rate hike has buoyed investors.

reserve bank of australia
The Reserve Bank of Australia became the first central bank to move away from outsized rate hikes Tuesday.REUTERS/Daniel Munoz
  • The Reserve Bank of Australia surprised the market by hiking interest rates by only 25 basis points.

  • It's the first central bank to move away from jumbo-sized rate increases to combat inflation.

  • The RBA's lower-than-expected rise will fuel hopes of a Federal Reserve pivot, analysts said.

Australia's central bank just surprised forecasters by raising interest rates by less than they anticipated — and that's lifting hopes the Federal Reserve will pivot to hiking interest rates less aggressively, according to analysts.

The Reserve Bank of Australia hiked rates Tuesday by 25 basis points rather than the 50 basis points estimated. Only seven of the 28 economists surveyed by Bloomberg projected that lower level before the bank's October meeting.

With the move, it became the first central bank to abandon jumbo-sized rate hikes. Over 80 central banks are raising rates right now in a bid to prevent high inflation becoming embedded in their economies and to prop up their currencies.

Its unexpectedly dovish decision is likely to give heart to investors looking for the Fed to move away from a fast pace of rate hikes, analysts said.

"Recent hopes of a pivot have disappointed," ING strategists said in a note. "Despite signs that a housing recession is already there, it is unclear whether economic circumstances have changed enough to prompt a policy change.

"Investors, however, may secretly be hoping for a slower pace of hikes going forward, or for quantitative tightening to be reconsidered."

"The RBA hiking only 25 basis points against a 50 basis point consensus overnight may well have reinforced these hopes."

The Fed has rattled markets with 75 basis point rate hikes at three consecutive meetings. Investors are bracing for another 50 basis point hike in November, despite fears that a housing market slowdown is signalling a potential US recession.

Meanwhile, the central bank is plowing ahead with a program of quantitative tightening, where it seeks to slash its balance sheet in a bid to cut the money supply and tame soaring prices.

A Fed pivot to a smaller rate hikes or even cuts in rate levels could in turn fuel a short-term rally in stocks, as borrowing costs would fall for companies and consumers.

In Sydney, the flagship S&P/ASX 200 index jumped 3.8% after the RBA decision, while the Australian dollar fell as much as 1% against its US counterpart.

In the US, stock futures gained ground in premarket trading Tuesday, with Dow futures up 1.4% and Nasdaq futures up over 2% at last check. Futures on the S&P 500 added 1.6%.

"There were multiple factors driving the rally, but the main one was growing speculation that central banks could soon pivot towards a more dovish stance, particularly after the market turmoil over the last couple of weeks," Deutsche Bank strategist Jim Reid said.

"The RBA move overnight will encourage more of that thought."

Like the Fed, the Australian central bank faces the task of avoiding an abrupt economic slowdown with its monetary tightening. The RBA's governor, Philip Lowe, underlined that policymakers was looking to cool inflation but keep the economy on an even keel at the same time.

"The path to achieving this balance is a narrow one and it is clouded in uncertainty," Lowe said in a statement.

But the ING strategists warned the Fed will likely need to see greater evidence that its rate hikes are driving an economic slowdown before it commits to a pivot.

Read more: The Fed has the world in its hands — and its aggressive moves are creating global economic chaos that could come back and hurt the US

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