Reserve Bank leaves the door open for more rate increases

Although it left the cash rate unchanged in April, the RBA’s decision was much closer than implied by markets, as it considered strong arguments for another increase.

Reserve Bank of Australia governor Philip Lowe. Picture: Gary Ramage

The Reserve Bank has dialled up its warning on the need for even higher interest rates.

While leaving the cash rate unchanged at 3.6 per cent in April after 10 consecutive increases from a record low of 0.1 per cent reached during the pandemic, the central bank’s decision to pause this month was evidently much closer than the zero chance implied by markets at the time.

Not only did the board discuss the arguments in favour of an April rate rise, it said it was “important to be clear that monetary policy may need to be tightened at subsequent meetings”.

Indeed, the RBA has left the door wide open for a restart of interest rate rises as soon as May.

Minutes from the April board meeting noted that quarterly CPI data next week, additional monthly readings on the labour market, household spending and business conditions, and further information on developments in the global economy and financial markets, together with a full set of updated forecasts, would be available to the board by time of its May 2 meeting.

“This suite of additional information would be valuable in reassessing the economic outlook and the extent to which monetary policy would need to be tightened further, especially given the range of uncertainties surrounding the outlook,” the minutes said.

RBA governor Philip Lowe and Westpac chief economist Bill Evans. Picture: Gary Ramage

“Members also noted that pausing after a run of monetary policy changes would be consistent with the typical pattern of policymaking before the pandemic.”

The money market reacted by lifting its implied chance of another 25 basis-point rate rise in May to about 20 per cent, from 12 per cent on Monday. The chance of an increase by August more than doubled to 60 per cent.

Westpac chief economist Bill Evans said the RBA was leaving its options open to raise the cash rate in May, and the case for doing so was much stronger than had been the case in April.

The minutes didn’t commit to considering a pause in May, and the RBA said market pricing that pointed to an extended period of rates on hold “reflected an average of both upside and downside scenarios”.

Moreover, the RBA showed a clear preference for higher rates.

Its February forecasts of inflation returning to target range only by mid-2025 “would be inconsistent with the board’s mandate for it to tolerate a slower return to ­target”, and noted that “these forecasts were conditioned on monetary policy being tightened a little further.”

“This comment is somewhat disturbing,” Mr Evans said.

“Calibrating policy on the basis of a two-year forecast seems risky – better to give more weight to the ‘here and now’ and, as we see in the minutes, ‘inflation remained too high, the unemployment rate was very low and surveyed business conditions were still strong’.”

The minutes raised several “new” arguments that point to upside inflation risks and support the case for tightening policy ­further.

A recent lift in near-term population projections “could put significant pressure on Australia’s existing capital stock, especially housing, which would in turn manifest in higher consumer ­prices”, and the fall in housing prices “might be smaller and more short lived than expected,” they said.

The RBA also saw an “increased risk of larger wage increases in parts of the economy, including the public sector”.

RBC Capital chief economist Su-Lin Ong. Picture: Hollie Adams

As with the comments from RBA deputy Michelle Bullock this week, the minutes said the pause in rate rises in April was ­motivated not by the US and ­Europe banking crisis. Rather, it wanted “to gather more information on the economic outlook”.

But two weeks after the April board meeting, Westpac’s Mr Evans said the RBA board’s “checklist” supported a rate rise, but the ultimate decision in May would be a “value judgment from the board, and the inflation report for the March quarter will be ­important.”

“A reasonable interpretation from the minutes of the April meeting is that a further increase of 0.25 per cent is a much more realistic outcome in May than was the case in April,” he said.

RBC chief economist Su-Lin Ong said the minutes showed a “clear tightening bias”.

Moreover, the RBA’s admission that its forecasts of inflation returning to the target range only by mid-2025 were inconsistent with the board’s mandate for it to tolerate a slower return to target is “a little worrying and continues to argue that the prudent approach is a more restrictive policy setting.”

The RBA board’s concerns about strong population growth and faster wages growth were “significant, likely to persist for some time and additive to growth and inflation”.

She also noted that the bank’s discussion around house prices may also feed into a slightly more positive growth outlook, with the minutes noting that “national established housing prices had steadied in March, following an 8 per cent decline from their peak around a year earlier”.

The minutes were more hawkish than the statement this month and showed that the RBA was nowhere near cutting rates, Citi chief economist Josh Williamson said: “All the risks highlighted by the minutes suggest that the board is prepared to hike rates further, rather than look for an avenue to loosen its current tight stance on monetary policy.”