The cash rate was lifted to 3.85 per cent on Tuesday (2 May) — marking the 11th hike in 12 months, now totalling a cumulative 375 bps.
The decision took markets by surprise, with the Reserve Bank of Australia (RBA) expected to pause its monetary policy cycle for the second consecutive month.
But in an address at a Reserve Bank dinner in Perth on Tuesday evening, governor Philip Lowe backed the board’s decision, claiming recent market signals suggested expectations of an end to cycle were inflating asset prices.
“Last month the board decided, after 10 consecutive interest rate increases, to hold the cash rate steady. It did this to provide us with more time to assess the pulse of the economy and the outlook,” he said.
“Since then, we have seen further evidence that the Australian labour market is still very tight, that services price inflation is proving to be uncomfortably persistent abroad, and that asset prices — including the exchange rate and housing prices — are responding to changes in the interest rate outlook.”
The governor acknowledged the latest quarterly consumer price index (CPI) confirmed inflation had passed its peak but stressed it would be “sometime yet” before inflation returns to its target range of 2–3 per cent.
“Goods price inflation is slowing, which is good news. But services and energy price inflation is still high and likely to remain so for some time,” governor Lowe continued.
“Looking overseas, we see worryingly persistent services price inflation. It is possible that circumstances might be different here in Australia, but the experience abroad points to an upside risk, especially given the high degree of commonality across countries in inflation dynamics recently.
“Given this flow of data and our assessment of the outlook, the board judged that it was appropriate to increase interest rates again today.”
Governor Lowe said while last month’s rate decision was “finely balanced”, the balance “tipped the other way” at the May meeting.
“We reached a strong consensus that this was the right time to move again,” he said.
The speech preceded the release of the latest retail trade data from the Australian Bureau of Statistics (ABS), which has reported a 0.4 per cent (seasonally adjusted) increase in March to $35.3 billion, up from 0.2 per cent in February.
However, in annual terms, retail sales growth slowed from 6.4 per cent to 5.4 per cent in the 12 months to 31 March 2023.
The ABS is scheduled to release its quarterly retail trade series next week, which is expected to better reflect the trend.
The Commonwealth Bank is projecting a 1.2 per cent decline in spending over the March quarter.
“We continue to expect consumer spending to slow from here as the impact of higher interest rates intensifies,” senior economist Belinda Allen wrote.
“The fixed rate home loans roll off is just gaining pace and variable rate mortgage holders will face another lift after the latest interest rate hike by the RBA at yesterday’s May board meeting.
The RBA was criticised for actioning a hike before viewing the latest spending data, given it had previously noted it would form part of its monetary policy determinations.
Its guidance also remains open to further tightening over the coming months.
According to Robert Carnell, regional head of research at ING Economics, the RBA’s forward guidance seems “inconsistent”.
“It certainly feels as if whatever message the RBA is trying to convey, they aren’t getting it across very effectively,” he said.
In fact, ING Economics had considered revising down its forecast for the terminal rate to 3.6 per cent, but is now projecting a peak of at least 3.85 per cent.
“…Beyond the very short-term, our base expectation remains that the rate hikes that have already been implemented will be enough to continue to deliver progress on inflation,” he said.
“And if we get more, then it reduces the chances of achieving a soft landing, and we may begin to see that reflected in lower, longer tenor bond yields if the RBA follows through on its latest hawkish guidance.”
Lowe defends RBA record
In his address, governor Philip Lowe sought to restore confidence in the RBA’s overall performance in recent years, drawing on the findings of the recently published RBA review.
This included support for the central bank’s inflation targeting framework.
“We are a strong institution that is served by a dedicated, diverse, and highly experienced board whose members have to grapple with very difficult issues,” he said.
“We have a strong focus on doing what is right for the country as a whole over the medium term, even if it is difficult for some people in the short term.”
The Albanese government accepted in-principle all 51 recommendations outlined in the An RBA fit for the future report.
Launched in July 2022, the review was designed to ensure Australia’s monetary policy arrangements and the operations of the RBA “continue to support strong macroeconomic outcomes for Australia in a complex and continuously evolving landscape”.
Key changes proposed include a major overhaul of the RBA’s decision-making processes, with a call to establish new, function-based, RBA boards (recommendations 8 and 12).
Specifically, a monetary policy board — responsible for monetary policy decisions and oversight of the RBA’s contribution to financial system stability (except payments system policy) — would operate separately from a new corporate governance board.
The monetary policy board would be chaired by the governor, who would work alongside the deputy governor, treasury secretary, and six external members.
The Treasury Secretary, who would act in their individual capacity not at the direction of the Treasurer, would be tasked with providing insight into the outlook for the economy and for fiscal policy.
The external members would be responsible for offering broader insight into macroeconomic trends, the financial system, labour market conditions, and supply-side influences.
Meanwhile, a separate governance board would be established to “provide guidance and oversight for RBA management in the running of the organisation” (recommendation 12).
This includes oversight of organisational strategy, financial reporting, large IT and other projects, resourcing, strategic staff planning, risk management (including cyber risk), and delivery of banking and banknote services.
The board would be mostly made up of non-executive members, one of whom would serve as chair.
Recommendation 12 stressed that the governance board “should have no role in monetary, financial stability or payments policy”.
According to the review, the dual-board model proposed under recommendations 8 and 12 would ultimately strengthen monetary policy decision making by helping maintain the RBA as a “high-performing institution in a complex and challenging future environment”; and enabling the monetary policy board to “focus solely on monetary and financial stability policy”.
However, the review stressed there must be a “clear division of responsibilities” within the RBA between all three of its boards (including the payments system board).
To ensure independence of the respective boards, the review has recommended the governance board’s charter restrict its oversight role and “avoid any involvement in the day-to-day running” of the RBA.
The boards should also establish a memorandum of understanding, recording the common understanding of their legislative responsibilities and their expectations for information exchange and consultation on matters of mutual interest.
