Following its decision to lift rates by a widely unexpected 50 basis points, governor Philip Lowe said the central bank “expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead”.
In a move that shocked economists, the Reserve Bank of Australia (RBA) pushed the rate up from 0.35 per cent to 0.85 per cent on Tuesday, citing the “current inflation pressures in the economy” and “the still very low level of interest rates” as catalysts.
“At its meeting today, the board decided to increase the cash rate target by 50 basis points to 85 basis points. It also increased the interest rate on Exchange Settlement balances by 50 basis points to 75 basis points,” the RBA governor said.
“Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected,” Dr Lowe continued.
While he highlighted global factors influencing inflation, Dr Lowe said “domestic factors are playing a role too, with capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices”.
“The floods earlier this year have also affected some prices.”
“Today’s increase in interest rates will assist with the return of inflation to target over time,” the governor said.
In making its June rate call, the board reflected on wages data but it also reaffirmed that having already entered inflation fighting mode, it would reduce emphasis on the wage price index over the coming months.
Last month, inflation spiked to its highest level in over two decades and while a blowout was predicted, economists didn’t quite expect such a sizable jump in both the headline and underlying inflation.
Following the inflation shock, the RBA upped its forecast for 2022, predicting headline inflation of around 6 per cent and underlying inflation of around 4.75 per cent. These are up from 3.25 per cent and 2.75 per cent respectively.
By mid-2024, the bank is expecting headline and underlying inflation to moderate to around 3 per cent.
Moving forward, Dr Lowe said the size and timing of future interest rate increases will be guided by the incoming data and the board’s assessment of the outlook for inflation and the labour market.
“The board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”
Markets split
While market economists were mainly confident in a June interest rate lift, they were split between a 25-bp and 40-bp hike.
Just before the RBA’s announcement, Joshua Rout, portfolio manager, fixed income, at Franklin Templeton, said “+25 bps is consistent with the RBA’s recent communications, but 40 bps gets them back to ‘standard’ increments, and recent solid Q1 data probably gives enough cover to go by the larger amount”.
The RBA’s decision is believed to have been made easier by last week’s strong national account report, which revealed that household consumption and broader domestic demand continue to grow at a solid pace.
However, Mr Rout does expect the RBA to press the pause button soon given falling house prices, sinking consumer confidence and negative wages growth.
“Our base case is the RBA hikes rates at the next few meetings before switching to quarterly rate increases starting in August,” he said.
This, however, is in stark contrast to current market pricing of 300 bps+ of rate increases over the next 12 months.
Also chiming in on the RBA debate, Anneke Thompson, chief economist at CreditorWatch, said, without a doubt, “today’s increase in the cash rate reflects the RBA’s increasing concern around price escalations across the economy”.
“Senior executives in the grocery, construction and logistics sector have recently been advising their customers to continue to expect prices to rise, as many products have not yet been fully repriced,” Ms Thompson said.
“July 1 is also a key date to consider, as many salaries are reviewed from this date, and a larger than normal repricing of consumables will probably happen at this time as well,” she noted.
Looking forward, Ms Thompson said the RBA will need to carefully balance both the cost of living and employment issues against rising inflation.
“The new Federal Treasurer Jim Chalmers has already indicated that inflation projections inherited by the new government will need to be revised upwards. This may see an upwards revision of the cash rate peaks by various market economists. However, offsetting this scenario is weaker than expected labour force data in April, when only 4,000 additional people became employed over the month.”
Inflation tipped to last
Last week, Larry Fink, the CEO of US$9.6 trillion asset manager BlackRock, predicted that inflation will likely remain elevated for a number of years.
In an interview with Bloomberg, Mr Fink suggested that inflation was not transitory and was being primarily driven by global supply chain issues.
“Demand right now in our economy is about equivalent to the demand that we saw pre-COVID, and so we’re witnessing all these supply shocks and that’s creating these attended price increases,” he said.
“It’s been aggravated now obviously by COVID and lockdowns in different parts of the world where we’re manufacturing goods. It has been further aggravated by the Ukraine-Russia war where we have supply shocks.”
Commenting on the local situation, AMP’s Shane Oliver also believes inflation is likely to get worse.
“Unemployment at 3.9 per cent is effectively at full employment. Wage growth is picking up. There is a danger that the longer inflation stays high and demand is strong, inflation expectations will rise, making it even harder to get inflation back down.”
As such, he noted the RBA needs to continue the process of normalising interest rates.
Dr Oliver earlier predicted that by year end, the cash rate would rise to between 1.5 per cent and 2 per cent.
