Biggest interest rate hike in 22 years

• The Reserve Bank (RBA) Board has lifted the target rate for the cash rate by 50 basis points (0.50 per cent) to 0.85 per cent, the biggest rate hike in 22 years and the first back-to-back rate hike since May 2010. The RBA increased the interest rate on Exchange Settlement balances from 25 basis points to 75 basis points.
• The Board said that it “is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”

What does it all mean?

• The ‘normalisation’ process continues. Clearly, ‘emergency’ level interest rates are no longer required for an economy in good shape with above-average economic growth, generational-low unemployment, record profitability and solid spending growth. And the RBA notes “inflation has increased significantly.”
• Apart from the ‘normalisation’ process, the Reserve Bank faces the same problem as other central banks in addressing the global inflation problem. The Covid-induced supply-chain issues, strong consumer demand for goods during lockdowns and the war in Ukraine are the key influences in pushing prices higher across the globe. There is not much central banks can do about those influences. But what they can do is try to slow down spending (demand) until production (supply) catches up.
• Most people would like to know the timing and size of future rate hikes well in advance, as well as how many rate hikes are likely to be necessary to slow down the economy. Unfortunately it is not as simple as that. The Reserve Bank is monitoring a broad array of domestic and global factors in determining the size and timing of interest rate hikes. This is more ‘art’ rather than science – hopefully it has mastered the art of rate hiking, but we have doubts.
• RBA Governor Lowe has said in the past that interest rates are not on a pre-determined path. The RBA knows that rates have to rise, but the size and timing of moves is not known with certainty. But the Reserve Bank implicitly acknowledges that it is fallen ‘behind the curve’ – it now needs to lift rates quickly to get ahead of the inflation threat, but the risk is that the economy slumps as a result.
• Commonwealth Bank (CBA) Group economists expect the cash rate to rise further in coming months: 50bp in July and then 25bp moves in August, September and November, taking the cash rate to 2.10 per cent by year-end.
• Given the significant lift in household debt taken on by Aussie consumers over the last few years, it will only take a few more interest rate increases to slow the economy to a pace consistent with inflation holding in the 2-3 per cent target band.