RBA has no option, but to raise rates in Aug

Reserve Bank Governor Michele Bullock may have to move in August. Picture: Nikki Short

The stark reality of Australia’s growing problem with sticky inflation is that the Reserve Bank of Australia may soon have to embark on a full-blooded extension of its tightening cycle, announcing not just one more rate hike, but delivering a series of increases to put the matter to rest.

The problem has grown clearer in the data over recent months, with inflation rising to 4 per cent in May from a year earlier, up from 3.6 per cent in April and 3.5 per cent in March.

The numbers need to be falling, not rising.

Trimmed mean inflation, a core measure of price growth that attracts the most attention from the RBA, rose to 4.4 per cent in May, putting it well above the central bank’s forecast of 4 per cent for the full year to June.

Those grim numbers follow a surprise high-side inflation shock in the first quarter consumer-price index and have been joined by recent business survey data showing that prices are still rising on several fronts.

There will have to be a stunning reversal in the inflation trajectory in June to allow the RBA to save face and avoid raising interest rates in August.

The trigger for a significant extension in the tightening cycle could well be delivered in a month’s time when the second-quarter CPI is published.

The RBA is already fearful that its goal of getting inflation back to the midpoint of its 2 per cent to 3 per cent target by mid-2026 is under extreme pressure.

RBA governor Michele Bullock told reporters this month that a lot of things have to go right if the central bank is to achieve its target on time.

They aren’t going the RBA’s way.

The RBA doesn’t really have the option of not raising interest rates in August and kicking the can down the road with a new forecast that sees the inflation target midpoint achieved in late 2026.

The RBA’s credibility would be eroded if it tried that.

Inflation has already been above the target band for many years, and any further delay in restoring price stability risks entrenching high inflation expectations and wage demands and perpetuating a cycle that will kill off hopes of near-term interest-rate cuts.

Extending the tightening cycle, with 425 basis points of hikes already delivered since May 2022, could involve the official cash rate moving well above 5 per cent, putting it on par with rates in other major economies.

“A high second-quarter CPI print means a series of hikes, and the best way to focus consumer minds and change the discretionary-spending psychology is to hike rapidly,” said Craig Vardy, Australia head of fixed income at BlackRock.

“Restarting a hiking cycle and then dragging it out just sets the RBA up for more inflation disappointment,” he said.

A complicating factor for the central bank’s policy-setting board is that the economy will get a further boost next week through income-tax cuts and direct government payments to households to help offset rising living costs.

The government cash handout to workers and households will spur aggregate demand just as it becomes painfully clear that inflation is remaining elevated.

“Inflation is not moderating as quickly as the board had hoped, meaning the stated aim of returning inflation to target in a reasonable time frame is definitely at risk, especially as the economy will receive a further boost from the tax cuts on 1 July,” independent economist Ivan Colhoun said.

“If it were me, I’d lock in an August rise and price 30-40 per cent of a follow-up increase in September or November,” Colhoun said.

A further run of interest-rate increases will almost certainly send the economy into a recession.

How deep the downturn goes will depend on how far the RBA has to hike.

– The Wall Street Journal