RBA board considered rate rise, minutes show

After the release of February RBA board minutes, economists believe the central bank will not raise rates further but the probability of a cut before November is low.

The Reserve Bank left interest rates unchanged last month as the risk of inflation taking too long to return to its target eased and there was a risk of a sharper fall in consumer spending.

But while considering the case for raising the overnight cash rate above its current level of 4.35 per cent, because the bank expects inflation to take another two years or so to hit the midpoint of its target band, the board didn’t even consider the case to cut rates after its February meeting.

According to the minutes of that meeting, the biggest economic risks were the potential for inflation to be more persistent than anticipated, productivity growth not to recover as assumed, and consumption to weaken more markedly than in the staff’s central forecast.

Whereas the RBA’s central forecasts show inflation returning to the target range of 2-3 per cent in 2025 and to the midpoint in 2026, and the unemployment rate rising modestly as growth in ­labour supply outpaces growth in employment, that assumes inflation expectations are “anchored” around the midpoint of the target range and that productivity increases to around its long-term average.

Members considered the policy implications of a scenario where inflation expectations gradually drift up and another where consumption is materially weaker than in the central forecasts.

“The case to raise the cash rate further centred on the observation that it would take some time for inflation to return to target and the labour market to full employment,” the minutes said.

“Increasing the cash rate target now would not prevent the board from easing monetary policy if the economy were to weaken more sharply than envisaged.”

The case to leave the cash rate target unchanged at this meeting centred on the observation that the risk of inflation not returning to the board’s target within a reasonable time frame had eased.

“The moderation in inflation over preceding months had been slightly larger than previously expected, and global inflation outcomes had provided additional confidence that inflation in Australia would moderate further,” the minutes said. “Data on the labour market and consumer spending had also been weaker than previously expected.

“Members noted that it was possible that conditions in the ­labour market were already consistent with full employment, although this was judged to be unlikely.

“In light of these observations, members considered whether to raise the cash rate target by a further 25 basis points at this meeting or to leave it unchanged.”

Uncertainty about the economic outlook was “high”, but the costs of not returning to target within the envisaged time frame were potentially very high, according to RBA board members.

“Given this, members agreed that it was appropriate not to rule out a further increase in the cash rate target,” the minutes said. “In light of these conclusions, members agreed that it was important for the board’s public statement to make clear that inflation had moderated but was still high, and that it was not yet possible to rule in or out further increases in interest rates.”

Overall the minutes backed the board’s post-meeting guidance that “the path of interest rates that will best ensure that inflation returns to target in a reasonable time frame will depend upon the data and the evolving assessment of risks, and a further increase in interest rates cannot be ruled out.”

However, the RBA’s forecast that inflation will hit the mid-point of its target band by the end of its forecast horizon in mid-2026 is based on a technical assumption for the cash rate, derived from market economists’ forecasts and market pricing that include no additional increase in the cash rate and a fall to 3.25 per cent by the middle of 2026.

The minutes reinforced expectations among economists that the RBA is on a path to start cutting interest rates between August and November this year.

Overnight index swaps pricing implied about 44 basis points of rate cuts by December.

Citi Australia senior economist Faraz Syed said: “Overall, we believe the bank likely will not hike any further, but the probability of near-term rate cuts is low, and we expect only two 25-basis-point cuts in August and November this year.

“Ongoing increases in the unemployment rate would be the catalyst for a more material ­dovish tilt. However, we still believe this is unlikely until around the middle of the year.”

JPMorgan chief economist Ben Jarman said the linking of the decision to keep rates unchanged to an easing of inflation risks after the latest CPI data “adds some meat to the guidance from the decision statement, where the board noted it had not ruled out further increases to the cash rate”.

“With the forecast return to the target band still relatively gradual, risks could re-emerge and we expect the board will be reluctant to rule out future increases for a while yet,” he said.

“Mention of potential hikes could then be sustained for a few meetings. However, the RBA’s balanced approach to its labour market and inflation objectives makes further tightening seem somewhat unlikely.”

Mr Jarman added that the “sense of the rate hike commentary being words for words’ sake was also revealed in the very ‘meta’ segment covering the board’s discussion of forward guidance itself”.

“This message is genuine to the extent it reflects the board’s true uncertainty regarding the inflation path, and serves its purpose in pushing back on prospects for near-term easing,” Mr Jarman said.

“However, with inflation now expected to be back at target at the same time window the board had ‘previously concluded was acceptable’, the prospect of another tightening should be reduced now that the endpoint is six months closer.”