RBA increases the cash rate and maintains the narrative that more may be required

The Reserve Bank has left open the amount of further interest rate increases that may be needed to get inflation under control.

The Reserve Bank has left open the question of further interest rate rises that may be needed to get inflation under control after surprising economists with another rate rise after its monthly meeting.

RBA governor Philip Lowe said the lift in the cash rate from 3.85 per cent to 4.1 per cent would “provide greater confidence that inflation will return to target within a reasonable time frame”.

Still, he repeated the previous month’s interest rate guidance, saying “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable time frame, but that will depend upon how the economy and inflation evolve”. “The board will continue to pay close attention to developments in the global economy, trends in household spending, and the outlook for inflation and the labour market,” Dr Lowe said.

“The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.”

At least one more 25 basis point interest rate rise had been expected this year after higher-than-expected CPI data and a larger-than-expected increase in the award wage announced last week. But the RBA was widely expected to pause again this month, as it did in April, to assess the economic impact of a rapid lift in interest rates over the past year.

Reserve Bank governor Philip Lowe. Picture: Martin Ollman

The increase contributed to a 1.2 per cent drop in the S&P/ASX 200 share index to 7129.6 points, wiping $30bn from its value.

It also lifted the Australian dollar from around US66.27c to a near three-week high of US66.85c.

Australian government bond yields rose, with the policy-sensitive three-year yield lifting as much as 12 basis points to an eight-month high of 3.68 per cent and the 10-year yield hitting a three-month high of 3.84 per cent.

Westpac chief economist Bill Evans said the rate decision was a significant surprise to markets, which had fewer than five basis points priced in.

The RBA has now delivered 12 rate rises in the current economic cycle, taking the cash rate from a record low of 0.1 per cent to a decade high of 4.1 per cent amid stubbornly high inflation.

In his statement, Dr Lowe maintained that inflation had peaked, while warning that the current level “at 7 per cent is still too high and it will be some time yet before it is back in the target range”.

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

“The statement, in highlighting that inflation is still too high – a point that we have stressed – gave a new prominence to ‘the importance of returning inflation to target within a reasonable time frame’,” Westpac’s Mr Evans said.

“This clear emphasis on inflation means that the next ‘live’ meeting is likely to be the August board meeting when the board will receive an update of the inflation path with the June quarter inflation report.”

In his statement, Dr Lowe said recent data indicated that the risks of higher inflation had increased, adding – in past tense – that “the board has responded to this”.

“While goods price inflation is slowing, services price inflation is still very high and is proving to be very persistent overseas,” Dr Lowe cautioned.

“Unit labour costs are also rising briskly, with productivity growth remaining subdued.”

He noted that economic growth had slowed and that labour market conditions had eased.

But conditions in the jobs market “remain very tight”.

Australian Chamber of Commerce chief executive Andrew McKellar.

Both job vacancies and job ads were “still at very high levels”, Dr Lowe noted.

“Wages growth has picked up in response to the tight labour market and high inflation”, growth in public sector wages was “expected to pick up further” and the annual increase in award wages was “higher than it was last year”, he said, in reference to the 5.75 per cent increase announced Friday. On a positive note, he said that at the aggregate level, wage growth was “still consistent with the inflation target” but that assumed “that productivity growth picks up”.

“The board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the still very low rate of unemployment,” Dr Lowe warned. “Accordingly, it will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms.”

Commonwealth Bank Head of Australian Economics Gareth Aird

Australian Chamber of Commerce and Industry chief executive Andrew McKellar said last week’s decision to increase award wages by 5.75 per cent forced the hand of the Reserve Bank. “If last week’s wage increase was brought to you by the ACTU, so too is today’s rate rise,” he said.

“The result of the ACTU’s irresponsible wages claim could not be clearer – wages growth not supported by productivity gains risks entrenching inflationary expectations and inflationary pressures.”

CBA’s head of Australian markets, Gareth Aird, also mainly attributed the rate rise to the Fair Work Commission’s decision to increase award rates by 5.75 per cent.

Royal Bank of Canada Australian chief economist Su-Lin Ong said the RBA was “trying to determine how restrictive policy needs to be for it to be more confident that inflation will return to target while trying not to push the economy into recession”, but “the narrow path is turning into a tightrope”.

Originally published as RBA increases the cash rate and maintains the narrative that more may be required