Reserve Bank says inflation is still too high and reinforces there’s more pain to come
Even after a massive lift in interest rates, the Reserve Bank dialled up its warning about the dangers of high inflation.
The Reserve Bank has dialled up its rhetoric about the need to lower inflation while repeating that it expects to increase interest rates further in the period ahead.
Even after Tuesday’s 25 basis point increase in the cash rate and a massive 300 basis point lift since May – equalling Australia’s biggest ever interest rate hiking cycle on record – the central bank saw fit to increase its warning about the dangers of high inflation.
In his post-meeting statement, RBA governor Philip Lowe repeated inflation is “too high” and “returning inflation to target requires a more sustainable balance between demand and supply”.
He continued to stress the “importance of avoiding a prices-wages spiral”, saying the board would “continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead”. But while noting that “there has been a substantial cumulative increase in interest rates since May”, which has “been necessary to ensure that the current period of high inflation is only temporary”, he also warned that “high inflation damages our 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,” Dr Lowe said.
The RBA’s November Statement on Monetary Policy forecast CPI inflation would peak at 8 per cent on-year in December.
By the end of the RBA’s forecast period in December 2024, the CPI was forecast to fall to 3.2 per cent, based on a technical assumption that the cash rate would peak around 3.5 per cent in mid-2023 before easing to around 3 per cent by the end of 2024.
Dr Lowe warned that “the labour market remains very tight, with many firms having difficulty hiring workers” as the unemployment rate fell to 3.4 per cent in October – its lowest since 1974.
But he didn’t repeat the observation he made in October and November that wages growth “remains lower than in other advanced economies where inflation is higher”.
Instead, he warned “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”.
He reiterated that the board “recognises that monetary policy operates with a lag and that the full effect of the increase in interest rates is yet to felt in mortgage payments”.
But while household spending was “expected to slow over the period ahead”, the “timing and extent of this slowdown is uncertain” and the “path to achieving the needed decline in inflation and achieving a soft landing for the economy remains a narrow one”.
Economists said Dr Lowe’s warnings on inflation were consistent with his guidance that the board “expects to increase interest rates further over the period ahead, but it is not on a preset course.”
“The Board has correctly maintained a strong tightening bias while emphasising the uncertainties in the outlook,” said Westpac chief economist Bill Evans.
“From our perspective it is encouraging that the governor has emphasised his awareness of the dangers of entrenched inflation – consistent with the views of other central banks such as the Federal Reserve.”
Goldman Sachs Australia chief economist Andrew Boak said Dr Lowe’s addition of the caveat that rates are “not on a preset course”, was “not a material shift in guidance”, since the RBA has frequently said rates are not on a preset course in previous minutes and speeches.
He expected the RBA to keep raising to a terminal rate of 4.1 per cent by May 2023, and said “we view risks as skewed to a somewhat more elongated tightening cycle”.
ANZ’s head of Australian economics, David Plank, said there was nothing in the RBA’s statement to challenge his view that the cash rate target will rise to 3.85 per cent by May 2023.
“While each move from here will be data dependent, we think the key numbers such as CPI and wages will leave the RBA with little option but to tighten further,” he said. “There was no indication in the statement that the board had considered pausing.”
While economists were almost unanimous in predicting a 25bp rate hike, the money market was less than fully priced for the move after monthly CPI data unexpectedly fell sharply last week.
Some economists had expected the RBA to significantly soften its forward guidance on rates.
The Commonwealth Bank revised up its terminal cash rate forecast to 3.35 from 3.1 per cent after the decision.
“The RBA has implicitly signalled a willingness to pause in the tightening cycle today … but the tweak in forward guidance was not as material as we anticipated, and as a result we shift our risk case to our base case,” said CBA’s head of Australian economics, Gareth Aird.
Nomura revised up its terminal RBA rate forecast to 3.85 from 3.60 per cent. While noting that the RBA’s guidance appears largely unchanged, Nomura chief economist Andrew Ticehurst saw it as a “modestly-hawkish development, given that we and others saw a risk of some more dovish words coming … today.”
But AMP chief economist Shane Oliver maintained that the RBA was “at or near the peak”.
“The speed of the rate hikes compared to the last three tightening cycles reflects the extent of the blow out in inflation and the low starting point for the cash rate,” he said.
“Our base case is that the cash rate has now peaked at 3.1 per cent, but with the RBA still retaining a tightening bias and upside risks of wages growth there is a high risk of one final 0.25 per cent hike to 3.35 per cent in February.”
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