The amount of tightening handed down to date, lags in the transmission of monetary policy, and the current “clearly restrictive” cash rate have been cited by the Reserve Bank of Australia (RBA) board as among the key reasons underpinning its decision to remain on hold in July.
But ongoing “very high” levels of inflation in Australia, and the minimal spare capacity in the economy and the labour market, did give the board reason to consider another rate hike.
The RBA confirmed the board again weighed up two options at its latest meeting: raising the cash rate by 25 basis points to 4.35 per cent or keeping it unchanged at 4.10 per cent.
“The case to increase the cash rate further was centred on the observations that inflation was forecast to remain above target for an extended period and there was a risk that this timeframe would be extended without further monetary policy tightening,” the RBA explained.
“Members noted that several CPI categories for which inflation was typically quite persistent already had too high inflation, including rent and services prices more broadly. They also observed that weak productivity was contributing to strong growth in unit labour costs.”
The labour market was described as being “very tight, notwithstanding some easing in conditions in the preceding month or so”, with the current environment seen as being conducive to above average increases in prices and wages.
The RBA board members observed that inflation in advanced economies had been more persistent than expected and said global central banks had delivered “unexpected or larger-than-expected” policy tightening as a result during the previous month.
They also pointed out the cash rate in Australia was “still lower than in many comparable economies and the recent experience of those countries highlighted the upside risks to inflation and the outlook for interest rates”.
“We continue to think there are good reasons for a lower peak; the pass through to mortgage holders, high household indebtedness and the RBA’s desire to hold onto gains in the employment market are some reasons,” noted Commonwealth Bank senior economist Belinda Allen.
The case to pause
Turning to the case to pause, board members stated that monetary policy had been tightened “considerably and rapidly” in Australia over the past year and added the stance of monetary policy was “clearly restrictive at the prevailing cash rate”.
“We are cautious about reading too much into the word ‘clearly’ (which appears to be new) but the sense is certainly that monetary policy is having an impact,” commented ANZ head of Australian economics Adam Boyton.
“Unlike the past few decisions, this one was not described as ‘finely balanced’. Again, we don’t wish to read too much into this, but it does seem that pausing in July might have been an easier decision for the board to come to than the hikes in May and June.”
In the meeting minutes, the RBA board members also highlighted the lags associated with the transmission of monetary policy through the economy, which they said meant that the full effects of the tightening that has occurred since mid last year had yet to be observed.
“They acknowledged that it takes time for households and businesses to adjust their spending and investment plans, and that there were still significant resets of low fixed-rate loans ahead. Similarly, demand for labour typically responds with a lag, which implied that the current tightness in the labour market might also ease,” the minutes read.
Members also warned there was considerable uncertainty about the resilience of household consumption, with pressure on household finances potentially resulting in consumption slowing more sharply than is implied by current forecasts.
“Higher interest rates could also be expected to encourage households to save more, which would affect consumption,” the RBA added.
“If that were to occur, the demand for labour would slow and the unemployment rate would be likely to rise beyond the rate required to ensure inflation returns to target in a reasonable timeframe.”
Weighing up the argument for and against a rate hike in July, the RBA board concluded that the case to keep the cash rate unchanged was stronger.
Given the uncertainty surrounding the outlook and the 400 basis points of tightening announced since May last year, members agreed to reassess the situation at their next meeting in August.
“Members agreed that some further tightening of monetary policy may be required to bring inflation back to target within a reasonable timeframe, but that this depended on how the economy and inflation evolve,” the RBA noted.
“At the August meeting, the board would have the benefit of additional data on inflation, the global economy, the labour market and household spending, as well as an updated set of staff forecasts and a revised assessment of the risks.”
Mr Boyton said the minutes did not change ANZ’s view on the outlook for the cash rate. Last week, the bank forecast an “extended pause” with no hike in August.
Meanwhile, Ms Allen confirmed that CBA’s base case is still for one final rate hike in August, taking the cash rate to 4.35 per cent, due to the concerns about the time it may take for inflation to return to the 2–3 per cent target band.
