The Reserve Bank of Australia Board has decided to increase the cash rate by 25 basis points to 3.85 per cent.
It also increased the rate paid on Exchange Settlement balances by 25 basis points to 3.75 per cent.
RBA suggests inflation in Australia has passed its peak, but at 7 per cent is still too high and it will be some time yet before it is back in the target range. Given the importance of returning inflation to target within a reasonable timeframe, the Board judged that a further increase in interest rates was warranted today.
The Board held interest rates steady last month to provide additional time to assess the state of the economy and the outlook. While the recent data showed a welcome decline in inflation, the central forecast remains that it takes a couple of years before inflation returns to the top of the target range; inflation is expected to be 4½ per cent in 2023 and 3 per cent in mid-2025.
Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve.
Goods price inflation is clearly slowing due to a better balance of supply and demand following the resolution of the pandemic disruptions. But services price inflation is still very high and broadly based and the experience overseas points to upside risks. Unit labour costs are also rising briskly, with productivity growth remaining subdued.
The recent Australian data also confirmed that the labour market remains very tight, with the unemployment rate at a near 50-year low. Many firms continue to experience difficulty hiring workers, although there has been some easing in labour shortages and the number of vacancies has declined a little.
The Board’s priority remains to return inflation to target. High inflation makes life difficult for people and damages the functioning of the economy. And if high inflation were to become entrenched in people’s expectations, it would be very costly to reduce later, involving even higher interest rates and a larger rise in unemployment. Medium-term inflation expectations remain well anchored, and it is important that this remains the case.
Wage growth has picked up in response to the tight labour market and high inflation. At the aggregate level, wage growth is still consistent with the inflation target, provided that productivity growth picks up. The Board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the historically low rate of unemployment. Accordingly, it will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms.
The Board is still seeking to keep the economy on an even keel as inflation returns to the 2–3 per cent target range, but the path to achieving a soft landing remains a narrow one. The central forecast is for the economy to continue growing, albeit at a below-trend pace; GDP is forecast to increase by 1¼ per cent this year and around 2 per cent over the year to mid-2025. Given the expected below-trend growth in the economy, the unemployment rate is forecast to increase gradually to around 4½ per cent in mid-2025.
A significant source of uncertainty continues to be the outlook for household consumption. The combination of higher interest rates, cost-of-living pressures and the earlier decline in housing prices is leading to a substantial slowing in household spending. While some households have substantial savings buffers, others are experiencing a painful squeeze on their finances. There are also uncertainties regarding the global economy, which is expected to grow at a below-average rate over the next couple of years.
Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve.
