RBA forcefully takes its ‘Christmas gift’ by hiking interest rates

Monetary policy operates with a lag and the full effect of the increase in interest rates is yet to be felt in mortgage payments.

Reserve Bank of Australia has decided to increase the cash rate by 25 basis points to raise it from 2.85 per cent to 3.10 per cent. It also increased the interest rate on Exchange Settlement balances by 25 basis points to 3.00 per cent.

RBA board thinks that at 6.9 per cent over the year to October inflation in Australia is too high. Global factors explain much of this high inflation, but strong domestic demand relative to the ability of the economy to meet that demand is also playing a role. Returning inflation to target requires a more sustainable balance between demand and supply.

A further increase in inflation is expected over the months ahead, with inflation forecast to peak at around 8 per cent over the year to the December quarter.

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Inflation is then expected to decline next year due to the ongoing resolution of global supply-side problems, recent declines in some commodity prices and slower growth in demand.

Medium-term inflation expectations remain well anchored, and it is important that this remains the case. The Bank’s central forecast is for CPI inflation to decline over the next couple of years to be a little above 3 per cent over 2024.

Reserve Bank Of Australia; Picture Source: @CANVA
Reserve Bank Of Australia; Picture Source: @CANVA

The Bank’s central forecast is for growth of around 1½ per cent in 2023 and 2024.

The Australian labour market remains very tight, with many firms having difficulty hiring workers. The unemployment rate declined to 3.4 per cent in October, the lowest rate since 1974.

Job vacancies and job ads are both at very high levels, although they have declined a little recently. Employment growth has also slowed as spare capacity in the labour market is absorbed.

Wages growth is continuing to pick up from the low rates of recent years and a further pick-up is expected due to the tight labour market and higher inflation. Given the importance of avoiding a price-wages spiral, the Board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead.

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There has been a substantial cumulative increase in interest rates since May.

RBA board claims this has been necessary to ensure that the current period of high inflation is only temporary. High inflation damages the economy and makes life more difficult for people. The Board’s priority is to re-establish low inflation and return inflation to the 2–3 per cent range over time.

RBA to raise cash rate within week; Image Source: @CANVA
RBA to raise cash rate; Image Source: @CANVA

The Board recognises that monetary policy operates with a lag and that the full effect of the increase in interest rates is yet to be felt in mortgage payments.

Household spending is expected to slow over the period ahead although the timing and extent of this slowdown are uncertain. Another source of uncertainty is the outlook for the global economy, which has deteriorated.

The Board is seeking to keep the economy on an even keel as it returns inflation to target, but these uncertainties mean that there is a range of potential scenarios. The path to achieving the needed decline in inflation and achieving a soft landing for the economy remains a narrow one.

The Board expects to increase interest rates further over the period ahead, but it is not on a pre-set course. It is closely monitoring the global economy, household spending and wage and price-setting behaviour.

The size and timing of future interest rate increases will continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market.