(May 5): Australia’s central bank raised its key interest rate for a third consecutive meeting, with governor Michele Bullock signalling policymakers would now pause to assess its next steps.
The Reserve Bank’s (RBA) nine-member policy committee opted to increase the cash rate to 4.35% from 4.1% by a vote of eight to one on Tuesday, unwinding all of last year’s cycle of monetary easing. The aggressive tightening underscored its determination to tame stubbornly strong inflation and cemented the RBA’s outlier status among global counterparts.
The rate hikes give the RBA scope to determine its next move, with policymakers watching if inflation expectations will stay anchored, Bullock told reporters.
“One reason to increase interest rates was to give ourselves space now to sit and see what happens,” she said. “We feel we are now in a position where we have got space, to be alert now to both sides of the risks to inflation — upside and downside.”
The currency swung between gains and losses as markets tried to assess how many more rate hikes the RBA is likely to deliver this year.
Traders trimmed expectations of rate hikes after Bullock’s comments on Tuesday, with the market pricing just one more increase in the third quarter. Prior to the press conference, they were pricing an almost 60% chance of two more by year end.
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The RBA’s tightening further separates Australia from international peers, ranging from the Bank of Japan to the US Federal Reserve, which have remained on hold citing war-driven uncertainty.
“On balance it appears that unless other price shocks emerge, employment strengthens further from current levels, or if it seems the Middle East conflict is likely to be extended for a longer period, the RBA will take their time before looking to adjust policy further,” said Tony Togher, the head of fixed income at First Sentier Investors.
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The RBA’s tightening puts further pressure on Australia’s centre-left government, a week out from the annual budget, which is expected to offer temporary cost of living relief to households from war-driven higher energy prices.
The US-Iran conflict has led to the effective closure of the Strait of Hormuz, the chokepoint connecting the Persian Gulf to global markets. Energy prices have soared as the waterway handled about one-fifth of the world’s oil and liquefied natural gas.
The strait remains at the heart of the stalemate as the US has since imposed a naval blockade on Iran, seeking to squeeze the Islamic Republic’s economy by preventing it from shipping its own crude.
“While we already had an inflation challenge in our economy the war in the Middle East is making this challenge worse, and we expect the impact of this to continue for some time,” Treasurer Jim Chalmers said in a statement. “The duration and severity of the conflict will determine how much more pressure it adds to global inflation and how much it is a hit to growth.”
The combination of higher borrowing costs and the spike in gasoline prices will lead to slower economic growth and higher unemployment, the RBA said in its latest quarterly update of economic forecasts. Core inflation is predicted to continue to overshoot the RBA’s 2-3% target through this year and into next.
“Australians are poorer because of this shock,” Bullock told reporters, referring to the oil price spike.
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The RBA lifted its near-term expectations for core prices materially, the statement on monetary policy showed. However, over a two-year horizon the inflation profile is better than the previous update in February, largely driven by its assumption of a higher cash rate, based on financial market pricing.
Under its latest forecasts, trimmed mean inflation is seen rising to 3.8% in June then cooling to 3.5% in December and 3.1% in mid-2027. It is then expected to come down further to near its 2.5% target midpoint by end-2027.
The latest estimates are based on an assumption of a cash rate peak of 4.7% over the forecast horizon. In February, the cash rate was seen hitting a high of 4.3% in December 2027.
The RBA operates under a dual mandate that aims for inflation at the 2.5% midpoint of its target while trying to keep the economy at maximum sustainable employment.
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