RBA keeps options open for September

The Reserve Bank of Australia’s (RBA) released its August monetary policy meeting minutes (16 August), which revealed the board decided to increase the cash rate by 50 bps, with no indication of increasing the cash rate by an alternative amount.

At its monetary policy meeting on Tuesday (2 August) the Reserve Bank of Australia (RBA) board decided to increase the cash rate by 50 bps, taking the cash rate to 1.85 per cent.

It marked the first time the central bank had increased the cash rate in three consecutive 50-bp hikes (following June and July’s 50-bp hike), continuing the rising rate cycle that started in May.

The latest minutes revealed the board’s decision boiled down to high inflation, around 7–10 per cent, “the resilient economy” and the tight labour market, which mirror the central bank’s justification for raising the interest rate in previous months.

The minutes stated inflation was now expected to “peak later and higher” than previously thought, with a further pass-through in cost pressures of 10–15 per cent in retail, gas and electricity prices.

However, fewer options appear to be on the table since June, where the board had weighed up a 25-bp or 50-bp, or July when “members considered the possibility of raising interest rates by 25bp or 50bp”.

In the August minutes there was no discussion of an alternative cash rate hike, other than the applied 50 bps, the board noted that members agreed it was appropriate to continue the process of normalising monetary conditions and “decided to increase the cash rate by a further 50 basis points”.

“The increase in interest rates over recent months has been required to bring inflation back to target by ensuring that inflation expectations remain anchored and establishing a more sustainable balance of demand and supply in the Australian economy,” the board stated.

Despite the widely anticipated 50-bp bump in August, the minutes reiterated that the board was “not on a pre-set path”, but would do what is necessary to scale back rising inflation to the target range of 2–3 per cent.

“The path to achieve this balance is a narrow one and subject to considerable uncertainty,” the board stated.

“The size and timing of future interest rate increases will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market, including the risks to the outlook.”

The decision comes given the deterioration in the global economic outlook, with the board stating “the risks to the global outlook were skewed to the downside.” Whereas, in the July minutes he indicated that the risks to the global outlook, “remained clouded” by the war in Ukraine.

In addition, as economists have begun to revise down their future cash rate predictions, the minutes also noted that the increase in interest rates over recent months “had been required” to bring inflation back and that the board wanted to ensure the economy was on an “even keel” when making future decisions.

The rising cost of living, falling house prices and higher interest rates were expected to weigh on consumption, with the board noting that “consumer confidence had already fallen significantly”.

“The rapid increase in the cost of living was weighing on real household incomes. It had also led central banks to increase interest rates quite quickly. Together, these developments were weighing on the outlook for global growth,” the board stated.

Commonwealth Bank (CBA) economist Gareth Aird said the minutes implied the board might be getting closer to a “pause in their tightening cycle”.

Mr Aird said the removal of the board’s reference to interest rates “still very low” in its August minutes, as compared to July, implied the board could be open to slowing down the pace of tightening.

“The RBA could shift to ‘business as usual’ 25bp monthly increments from here, particularly if the data over the next two days supports the case to slow the rate of policy tightening,” Mr Aird said.

“A 40bp hike could also be on the table. It would carry the dual benefit of restoring the cash rate to a more conventional metric whilst also sending a signal to an anxious household sector that the pace of tightening will moderate.”

However, CBA’s central scenario remains “unchanged”, with the bank’s economists expecting the RBA to lift the cash rate by 50 bps in September.

“We see the cash rate target peaking at 2.60 per cent in late 2022 (a level which we consider to be contractionary). And we have two 25bp rate cuts pencilled in for H2 23,” Mr Aird said.

“We think that provided the RBA pause in their tightening cycle when the cash rate is around 2.60 per cent the data will indicate that there is no need to continue to take the policy rate higher.”

Mr Aird also noted the lag between changes to the cash rate and the impact on mortgages.

“At CBA, for example, by December the impact of already announced rate rises on monthly cash flow for mortgage holders will be a four-fold increase compared to July,” Mr Aird said.

‘There isn’t a wage-price spiral’

The RBA’s August minutes also noted the effect of high inflation on wageand price-setting behaviour, which presented a “material risk to the inflation outlook”.

Members noted that firms continued to expect wages growth to be higher in the period ahead, with “over 60 per cent of private sector firms” indicating that they expected to raise wages by more than 3 per cent over the year ahead.

“Recent high inflation outcomes were a factor in current wage negotiations, but to date most firms expected to raise wages by less than inflation,” the minutes revealed.

The Australian Bureau of Statistics reported, that on 17 August, the wage price index (WPI) rose by 0.7 per cent in the second quarter of 2022.

Mr Aird said that whilst wages growth across the economy is moving higher and some people are receiving large pay rises, there have not been broad-based wages pressures.

“Indeed real wages growth (as measured by headline inflation deflated by the wage price index) is deeply negative,” Mr Aird said.

“The RBA is not facing a wage-price spiral like is being observed in some other jurisdictions [and] does not have to run hard against wages growth by aggressively hiking the cash rate.”