RBA Frets Over Inflation Risk in ‘Finely Balanced’ Rate Call

Australia’s central bank weighed the risk of upside surprises to inflation from a tight labor market and rising home prices when it decided to deliver a surprise interest-rate increase this month.

(Bloomberg) — Australia’s central bank weighed the risk of upside surprises to inflation from a tight labor market and rising home prices when it decided to deliver a surprise interest-rate increase this month.

The Reserve Bank’s board discussed the case to pause but concluded the “finely balanced” arguments were in favor of raising the cash rate to 4.1% — a level not seen since April 2012. The decision came after a monthly inflation indicator for April unexpectedly accelerated. 

“The recent data suggested that inflation risks had shifted somewhat to the upside,” the minutes of the RBA’s June 6 meeting showed Tuesday. “Given this shift and the already drawn-out return of inflation to target, the board judged that a further increase in interest rates was warranted.”

The close nature of the decision and strong case for a pause prompted traders to pare bets the RBA will hike twice by year-end. The Australian dollar dropped the most in three weeks and the yield on policy sensitive 3-year notes erased a gain of as much as six basis points while stocks extended gains.

“We didn’t read the minutes as particularly hawkish,” said Adelaide Timbrell, an economist at ANZ Bank Holdings Ltd. “There was no talk of whether further rate increases were needed.”  

The minutes were followed by a speech from Deputy Governor Michele Bullock who warned that unemployment will have to rise toward 4.5%, from 3.6% now, for inflation to return to target. Official forecasts show headline CPI only reaching the top of the 2-3% goal in mid-2025, from 7% now.

Responding to questions following her speech at an industry event, Bullock reiterated that the RBA is closely watching inflation, employment, household consumption and the global economy.

“We are data dependent,” she said. “We are not actually on a pre-set path. We are basically watching very closely what’s going on.”

Even after this month’s surprise move, Australia has lagged global counterparts in its policy response to higher prices, having raised rates by 4 percentage points since May 2022, well below that of New Zealand and the US. 

That reflects Governor Philip Lowe’s desire to preserve employment gains in his battle against inflation.

The RBA’s minutes highlighted a tight labor market and accelerating services inflation among reasons for its June hike. Other factors included:

  • A stabilization in home-loan approvals which suggest that financial conditions may not be as tight as previously thought
  • Disappointing productivity growth over recent times, an outcome that threatens to keep unit labor costs elevated
  • The possibility of implicit indexation of wages to past high inflation and the chance for it to become widespread
  • Some firms indexing their prices, either implicitly or directly to past inflation
  • A decision by the country’s industrial relations umpire to raise the national minimum wage by 5.75%, which would add directly to the wage price index in the third quarter

Economic data since the RBA meeting have been mixed, however. 

Figures this month showed the economy slowed at a faster-than-expected pace in the first three months of the year; business confidence slipped into negative territory and consumer sentiment hovered near “recession lows.” On the flip side, employment gains smashed expectations and the jobless rate surprisingly fell.

Economists say the picture has become more challenging lately with a recession — defined as two consecutive quarters of contraction – now a real possibility, driven by the RBA’s aggressive tightening.

Goldman Sachs Group Inc. is among the most hawkish forecasters, predicting a peak RBA rate of 4.85% while Commonwealth Bank of Australia expects the central bank will now stand pat.

The minutes showed the case for leaving the cash rate unchanged this month rested on a slowdown in activity and expectations that the “significant” hikes to date would further cool economic growth.

Members also discussed downside risks to inflation, including falling commodity prices and international shipping costs.

“Members recognized the strength of both sets of arguments, concluding that the arguments were finely balanced,” the minutes showed. “They judged, though, that the case to raise the cash rate at this meeting was the stronger one.”

–With assistance from Matthew Burgess and Georgina McKay.

(Adds Deputy Governor Bullock, comment from economist.)

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