Reserve Bank lifts rates for first time in 11 years

Reserve Bank Board meeting

The Reserve Bank (RBA) Board has lifted the target rate for the cash rate by 25 basis points (0.25 percent) to 0.35 per cent. The RBA chose a 25 basis points rate move to signal ‘getting back to usual’. The RBA increased the interest rate on Exchange Settlement balances from zero per cent to 25 basis points.

The RBA Board has announced that it will not reinvest the proceeds of maturing bonds. The Board said that it “is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead.” The RBA Governor said that it wasn’t unreasonable to expect rates to rise to 2.5 per cent over time.

What does it all mean?

Interest rates have risen for the first time in 11½ years. While bad news for borrowers, an increase in interest rates represents good news for the nation’s depositors. And certainly more Australians have been squirreling away cash over the past few years. Deposits from households stood at a record $1,261.6 billion in March, up by 12.3 per cent on a year ago. Aussie families have accumulated $272.4 billion worth of savings during the pandemic.

When the Reserve Bank lifts rates, those people that are paying off loans have fewer dollars to spend. That means that businesses, especially retailers, need to keep prices low to keep people spending. So slower growth in spending (or demand for goods) has the potential to restrain price increases or inflation more broadly.

The Reserve Bank surprised by lifting rates by 25 basis points (0.25 percentage points) – economists had expected rates to be lifted by either 15 basis points or 40 basis points. Commonwealth Bank (CBA) Group economists expect the cash rate to rise in coming months, lifting to 1.60 per cent in the March quarter 2023.

Given the significant lift in debt taken on by Aussie consumers over the last few years, small interest rate increases should have a bigger impact in slowing the economy to a pace consistent with inflation holding in the 2-3 per cent target band.

The Reserve Bank appears worried by the lift in inflation expectations. If consumers and businesses start to base decisions on higher rates of inflation like 5 per cent (5.3 per cent according to the latest ANZ/Roy Morgan consumer confidence data) rather than 2 or 3 per cent, then there is a risk of inflation becoming locked in at a higher level. Once the inflation horse has bolted, it’s harder to get it back in the stalls. So the Reserve Bank has embraced a combination of rate hikes and ‘jawboning’ to bring the inflation rate back into the target band.

The assessment

With inflation higher than it expected, the Reserve Bank says now is the right time to begin withdrawing some of the extraordinary monetary stimulus.

Despite the likelihood of rate increases over the next year, the RBA says that the outlook for the economy remains positive and expects the jobless rate to hit a 50-year low of 3.5 per cent in early 2023. Of particular importance the RBA says: “Macroeconomic policy settings remain supportive of growth and national income is being boosted by higher commodity prices.”

The Reserve Bank had previously said that it would wait for evidence of higher wage growth before lifting rates. The evidence was expected to come from the Wage Price Index (to be released on May 18). But the RBA said it has indeed received the wages evidence, but rather from its ‘business liaison’ programme: “the more timely evidence from liaison and business surveys is that larger wage increases are now occurring in many private-sector firms.” The most recent NAB business survey showed that annual labour costs grew at 2.7 per cent in the March quarter of 2022, a series high.

Perspectives on interest rates

The RBA lifted the cash rate by 0.25 percentage points to 0.35 per cent. This is the first rate change in 16 consecutive Board meetings. The RBA last cut the cash rate from 0.25 per cent to 0.10 per cent on November 3, 2020. The last time the RBA lifted the cash rate was November 2, 2010 – up from 4.50 per cent to 4.75 per cent. Before the Covid-19 health and economic crises, the official cash rate was 0.75 per cent on February 5, 2020.

Implications

The RBA says that it “is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.” This indicates that the RBA has become more ‘hawkish’ and will use a combination of ‘jawboning’ and interest rate hikes to ensure that inflation target returns to the 2-3 per cent target band.

Before the pandemic, the cash rate was 0.75 per cent. Even with today’s rate hike, the cash rate is still less than half the pre-pandemic levels.

Originally published by CommSec