RBA's close call on rates offers no solace for months ahead

The Reserve Bank of Australia (RBA) on Tuesday (18 October) made it clear to the Australian public that the unexpectedly small interest rate rise earlier this month would not mean the rate hike cycle was over.

Minutes from the central bank’s October board meeting revealed that it was a close call during their internal discussions about whether to lift the official cash rate by 0.25 or 0.5 per cent.

In opting for the smaller rise of 25 basis points, Australia became the first of the advanced economies to make such a move. It also ended a record run of four consecutive increases of half a percentage point.

But borrowers have been left in little doubt that more interest rate rises are around the corner, as the RBA continues its assault on stubbornly high inflation.

“The Board agreed on the importance of returning inflation to target and the need to establish a more sustainable balance of demand and supply in the Australian economy (and) this was likely to require further increases in interest rates over the period ahead,” the Minutes of the Monetary Policy Meeting noted.

Weighing its options

In justifying its decision to opt for the smaller rate rise option, the RBA also made a relatively unusual of falling prices, having said in the past the property market was not its responsibility.

“The tightening of monetary policy was having a clear effect in the housing market, where prices had declined after earlier large increases, and the demand for housing loans had also fallen.

“Previous episodes of lower housing prices and turnover had seen a large effect on consumer spending, in part through the wealth channel of transmission.”

The RBA did, however, say that its primary argument for the 0.25 per cent increase rested on the risks to global and domestic growth, and the potential for inflation to subside quickly.

“The cash rate had risen by a significant amount in a short period of time.

“While consumption had so far held up, monetary policy operated with a lag and there was a risk that household spending might adjust by more than expected.

“Higher interest rates, alongside higher inflation, were putting pressure on household budgets and consumer confidence had fallen,” the RBA Board noted.

The arguments for continuing with an increase of 50 basis points are as prevalent now as they have been over the past few months, and stemmed from the inflationary environment and risks to inflation expectations.

Inflation is high and still expected to increase further.

The RBA said inflationary pressures had earlier proven more persistent than expected and there were upside risks to inflation from the labour market, rents and energy costs.

“While wages growth had increased more rapidly in other economies where labour supply had been more adversely affected by the pandemic, Australia could yet have the same experience given the tightness of the labour market.

The RBA also showed it was little different to most people, in worrying about what other countries might think.

In acknowledging it would be the first advanced economy to tone down its rate hike agenda, the RBA expressed concerns about the market might react in judgement.

“This (a lessened 0.25 per cent hike) might in turn prompt an unhelpful reaction in inflation expectations and financial markets if the community came to question the Board’s resolve to reduce inflation.

“Ultimately, if upside risks to inflation were to materialise, or the credibility of the path to reduce inflation came into question, it would be costly to re-establish low inflation.”

The average variable interest rate for owner occupiers paying principal and interest is 5.09 per cent and the lowest variable rate is 3.54 per cent. The average variable interest rate for investors paying principal and interest is 5.42 per cent and the lowest rate is 3.79 per cent.

Before Tuesday’s release of the October meeting minutes, investors were predicting another 25 basis point increase by the RBA at the 1 November meeting, giving this a four-in-five chance. Markets were also expecting the cash rate to approach 4 per cent by the second half of next year.

Policymaking explained

In a speech delivered Tuesday to the Australian Finance Industry Association (AFIA), Michele Bullock, RBA Deputy Governor, shed some insight into how the RBA goes about making its decisions on monetary policy.

“We aim to have consumer price inflation average between 2 and 3 per cent over time.

“How do we go about determining every month the best stance of monetary policy in order to meet this goal? The first step is extensive ongoing monitoring and analysis of data on inflation, the domestic and international economies, financial markets and financing conditions,” Ms Bullock said.

She added that the Australian Bureau of Statistics produces high-quality data on all aspects of the Australian economy – income, production, the labour market, trade, investment, consumption, inflation and so on – which provides the RBA with a good view on where the economy is at and the trends within it.

Ms Bullock also said the RBA meets more frequently than many other central banks.

“The Reserve Bank board is making monetary policy decisions 11 times a year so it is discussing regularly the evidence on the economy and has more flexibility on the size and timing of rate increases,” she said.

“It means that we can increase rates at every meeting and we can achieve a similar rise but in smaller increments,” she said.

“We still feel that there is a path for us here where we can get inflation down, not go into recession, preserve most of the gains in employment that we’ve had,” Ms Bullock told the AFIA annual conference.

If it is to follow other comparable economies, the RBA still has some ground to make up, having been one of the last central banks to begin the process of lifting rates.

“The incremental change in the policy rate at recent meetings has been smaller than some other major central banks, however, our policy rate trajectory has been as steep, or steeper, than other central banks,” Ms Bullock said.