The Reserve Bank has announced the biggest rise in the cash rate in 22 years as Australia’s central bank tries to quash inflation before it gets out of control.
At its regular monthly meeting, the RBA board, lifted its cash rate target by 50 basis points to 0.85%. Economists were again surprised by the size of the move, having been mostly split between predicting a 25 or 40-point increase, according to Bloomberg.
Households and businesses already bear higher costs for everything from food to construction materials and energy. To this load will be added higher repayment costs for those on variable loans, with the main commercial banks likely to pass on today’s rate rise promptly.
“Inflation in Australia has increased significantly,” said the RBA governor, Philip Lowe, in a statement.
“While inflation is lower than in most other advanced economies, it is higher than expected.
“Inflation is expected to increase further but then decline towards the 2% to 3% range next year. Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago.”
Difficult news for homeowners already facing skyrocketing living costs, including spiking energy prices. A better future awaits, but first, we must navigate this inflation challenge we inherited and the rising interest rates that accompany it. #ausecon #auspol
— Jim Chalmers MP (@JEChalmers) June 7, 2022
The treasurer, Jim Chalmers, earlier on Tuesday said, “it’s going to be a difficult winter for a lot of people with what we’re seeing now with prices and wages combining at the same time”.
Chalmers will probably have to address regular increases in interest rates in the coming months as the RBA changes tack after keeping the cash rate at record-low levels to support the economy through the Covid pandemic.
Cash rate over time
“The board expects to take further steps in the process of normalizing monetary conditions in Australia over the months ahead,” Lowe said, indicating more rate rises to come.
The RBA’s medium-term goal is to have an underlying inflation range between 2% and 3%, compared with a 3.7% pace in the March quarter that’s expected to accelerate in the current quarter, if not beyond. Power price increases of 10% or more will kick in for many households and businesses from 1 July, a rise that will have knock-on effects.
The Albanese government inherited an economy with a jobless rate at its lowest since the mid-70s but an underlying inflation rate running at its highest quarterly pace since 2002.
The headline consumer price inflation rate was 5.1% for the March quarter, with automotive fuel up 35%, the most since Iraq’s 1990 invasion of Kuwait. The current spike in energy prices has similarly been made worse by war after Russia invaded Ukraine in February. Covid-related interruptions to supply chains have also pushed up prices.
“The RBA has pointed to a stronger outlook for energy prices compared to a month ago as the main protagonist for the outsized move,” said Sean Langcake, the head of macroeconomic forecasting for BIS Oxford Economics.
Despite the imported source of much of the inflation, the RBA sees the need to rein in excessive demand to ensure expectations of different prices don’t lead to a spiral of costs.
Impact if rates rise to 2.50% by the end of 2023
The RBA noted housing prices had declined in some markets over recent months but remained more than 25% higher than before the pandemic, providing a wealth effect that would support spending even as rates rise. The saving rate also remains higher than pre-Covid – although it fell in the March quarter – and many households had built up “large financial buffers” to help them cope with the higher debt repayment costs.
The challenge facing most central banks is how to return interest rates to pre-pandemic levels and curb price increases without stunning economies into recession.
Australia’s problems are shared in many similar economies. Last week, Canada’s central bank lifted its cash rate by 50 basis points for the the second month in a row.
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New Zealand last month hiked its rate half a percentage point to 2%, while the US and the UK are also raising rates. Only the European Central Bank has held off despite inflation reaching an annual rate above 8%.
The senior manager for business policy at CPA Australia, Gavan Ord, said the country had a “major flaw” in how it reports inflation because the numbers are only released quarterly, providing forecasters with a partial view of the economy’s health.
“These are the same figures it relied on to raise interest rates by a quarter of a percent in May and will be the same figures it relies on at its July meeting,” Ord said. “By contrast, the US Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank of England, for example, all have access to data within weeks of making a decision.”
