Tuesday’s RBA meeting: Interest rates held but central bank flags massive policy changes

The Reserve Bank of Australia has unveiled massive changes to monetary policy as well as signalling its intent on interest rates.

The official cash rate has been kept at a record low 0.1 per cent – for now – while the Reserve Bank of Australia has confirmed it will halt the extraordinary money printing program that helped carry the economy through the Covid-19 crisis.

RBA Governor Philip Lowe on Tuesday also admitted the red-hot inflation roiling financial markets had exceeded his predictions, prompting him to upgrade the central bank’s economic forecast and set the scene for a potential 2022 rate hike.

Despite a roaring economic rebound, Australia’s official cash rate was not predicted to shift on Tuesday, and was indeed held where it has been since November 2020, having last increased in 2010.

But homeowners and economists were still on the edge of their seats ahead of one of the most anticipated meetings of the board in history.

As expected, the first RBA meeting of 2022 brought an end to its massive money printing program – with final bond purchases to cease on February 10 – echoing a move that was signalled by the US Fed in December. Picture: NCA NewsWire / Jeremy Piper

Surging inflation and a better-than-expected improvement in the jobs market stoked expectations the RBA would join other central banks in winding back huge levels of financial support, lest the forces currently roiling financial markets get out of control.

And, as expected, the first meeting of 2022 brought an end to its massive money printing program – with final bond purchases to cease on February 10 – echoing a move that was signalled by the US Fed in December.

Since the start of the pandemic, the RBA’s balance sheet has more than tripled to around $640 billion.

The Reserve Bank also upgraded its economic forecasts, with the unemployment rate now expected to ease from 4.2 per cent to 4 per cent by the end of 2022, an upgrade of 0.25 per cent points on its November forecast.

Underlying inflation is expected to reach 3.25 per cent this year – a full percentage point above their November forecast.

Dr Lowe has previously said there will be no rate hike until at least 2023, but the economic recovery has led economists and financial markets to tip an August rise, with July or June as an outside chance.

“At first glance, the combination of high inflation and low unemployment suggests that a rate hike should be imminent,” said Indeed.com’s APAC economist, Callam Pickering.

“The global pandemic obviously complicates matters, with high inflation largely a product of global supply chain issues.

“Australia has basically imported high inflation from abroad; it will be difficult for the RBA to meaningfully change that through tighter monetary policy. Raising rates in the current environment may prove futile for that very reason.”

While the RBA board is widely expected to hold the cash rate at a record low 0.1 per cent on Tuesday, economists have increasingly noted that predictions made by governor Philip Lowe have vastly undershot the speed of the nation’s financial recovery. Picture: Richard Dobson

The speed of Australia’s economic rebound has taken many by surprise – including, it seems, the RBA – indicating that ultra-generous support measures were due to be wound back sooner rather than later.

“It’s fair to say that the RBA forecasts for underlying inflation have missed the mark by a significant margin over the past year,” the Commonwealth Bank’s economics team says in its February RBA preview.

“By extension, this means that their central scenario for the inflation outlook is not playing out as they expected.”

In Tuesday’s statement, Dr Lowe admitted inflation had picked up faster than the RBA had expected, but noted it remains lower than in many other countries.

“The central forecast is for underlying inflation to increase further in coming quarters to around 3.25 per cent, before declining to around 2.75 per cent over 2023 as the supply-side problems are resolved and consumption patterns normalise,” Dr Lowe said.

“One source of uncertainty is the persistence of the disruptions to supply chains and distribution networks and their ongoing effects on prices. It is also uncertain how consumption patterns will evolve and how this will affect the balance of supply and demand, and hence prices.”

Anticipating higher rates, the Australian Prudential Regulatory Authority in October announced an increase to the loan affordability buffer from 2.5 percent to 3 per cent, further accentuating the impact of any rate hikes. Picture: NCA NewsWire / Gaye Gerard

Westpac recently announced it expects the cash rate to reach 1.75 per cent by 2024 following a series of hikes.

Canstar analysis shows if the cash rate rose to 1.75 per cent, the average variable interest rate would increase from 3.04 per cent to 4.69 per cent.

If this were to occur, single buyers on the median annual income of $77,900 could see their borrowing power reduced by $71,000 down to $388,000, while a couple earning the median combined income of $155,800 could see their borrowing power fall by $169,000 to $921,000.

At its meeting today, the Board decided to maintain the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero per cent. It also decided to cease further purchases under the bond purchase program – https://t.co/xlIW5gFjt2

— RBA (@RBAInfo) February 1, 2022

“When the Reserve Bank hits the button on cash rate increases, history shows that it doesn’t stop at one or two hikes, and usually results in at least a 1.5 percent increase over 18 months or so,” Canstar’s finance expert, Steve Mickenbecker, says.

“When the Reserve Bank moves the cash rate up, you can be sure the banks will move home loan rates up too, meaning higher loan repayments. For borrowers entering the property market or trading up, this also means the capacity of incomes becomes stretched, meaning they are forced to borrow less.”

Also anticipating higher rates, the Australian Prudential Regulatory Authority in October announced an increase to the loan affordability buffer from 2.5 percent to 3 per cent, further accentuating the impact of any rate hikes.

“Many borrowers only remember interest rates falling,” Mr Mickenbecker said.

“This means a drop in borrowing power will come as quite a shock to buyers already facing the prospect of continuing runaway house prices.”

The Aussie dollar dipped on the release of Tuesday’s statement, and was last trading at 70.39 US cents.

The local sharemarket ticked higher on the news – the ASX200 was last up by more than 1 per cent.

The speed of Australia’s economic rebound has taken many by surprise – with red-hot inflation figures currently roiling financial markets – indicating that ultra-generous support measures need to be wound back. Picture: NCA NewsWire / Jeremy Piper