Rate Rethink: Further Hikes to Come

February 2023

Before the Feb meeting, the consensus was there would be a rate hike in Feb, with another rise to be delivered at one of the following Board meetings.

The Statement post the meeting though was more aggressive on the potential for more rate hikes than most had expected. The Q4 inflation number would have been a key factor in the change in view by the RBA although more optimism about the short-term global economic outlook may have played a role.

The RBA subsequently released its Monetary Policy Statement (MPS) that gave more detail about its forecasts. The MPS did not make it clear as to why the RBA had become more aggressive. A better hint came from the Governor’s testimony before the Senate when he noted the big price rises in parts of the CPI (such as travel) he largely attributed to strong demand. He also mentioned that Australia has not benefitted from the decline of good prices to the same degree as other countries (such as the US).

In both the Statement following the decision and the MPS was the very prominent sentence, “the RBA expects that further increases in interest rates will be needed over the months ahead…”. Noting the plural, most market economists appear to have shifted their view of the peak in the cash rate to at least 3.85% (some are higher).

This does not necessarily mean that the RBA’s central-case scenario is that inflation will stay too high. But it might mean that they think the risks that it might stay too high have got to an uncomfortable level following the release of the Q4 inflation numbers. And because the economic problems caused by inflation are so large it means that on a risk management basis, higher rates than what they had previously thought become necessary.

The combination of slowing demand and rising supply of workers (due to strong immigration growth) will mean labour shortages will be less of an issue by this time next year. Another weak jobs number though would challenge this view.

Clearly, the higher interest rates go at a time of high household debt, the greater the chance that the economy could slow sharply. That is unlikely to happen with a cash rate at 3.85%, but we don’t know for certain as to how high the RBA thinks that the cash rate will need to go to get inflation back under control. And how the economy will react to higher interest rates.

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