The RBA has responded to rising wage and inflation pressures by commencing its hiking cycle at today's meeting and signalling a series of further hikes to come through the remainder of 2022 into 2023. A robust outlook for Australian economic growth and a tightening labour market mean policy will be directed at containing inflation, with a frontloaded hike possible at the next meeting in June.
May meeting decisions
A determination that the Australian economy no longer needs a policy rate at the emergency lows of the pandemic led to the Board hiking its key interest rates by 25bps today. This has increased the cash rate target from 0.1% to 0.35%, while the rate on Exchange Settlement balances was lifted from 0% to 0.25%. As anticipated, this retains the 10bps spread in the cash rate target over the rate on Exchange Settlement balances that the RBA has had in place since November 2020. The actual cash rate will now trade in the range between 0.25% to 0.35% (up from 0% to 0.1% previously). In effect, the RBA met those calling for a hike today halfway between a 15bps (my call) and 40bps increase.
The Board also announced the start of quantitative tightening (QT), informing markets that it will not reinvest the proceeds from its maturing bond holdings, though it said it has no plans to actively sell bonds back into the market. This decision was expected and means QT will commence in July, which is when the next maturing Australian government bond line falls. As covered in the preview, QT will do more of the heavy lifting in tightening the monetary policy stance from 2023 onwards, so the focus is very much on the policy rate for now.
Rising wage-price pressures prompt a recalibration of policy
While many central banks are likely to face an increasingly difficult trade-off between supporting growth prospects and curbing inflation as 2022 progresses, the RBA's situation is much more favourable. In today's decision statement and in his post-meeting press conference, Governor Philip Lowe reiterated domestic growth prospects are robust in 2022 with GDP growth of 4.25% expected before slowing to 2% in 2023. These forecasts are unchanged from February despite rising caution around the headwinds to global growth from the Ukraine war, China's lockdowns and the squeeze on consumption from high inflation.
A favourable growth outlook means the Board will concentrate policy on containing inflation. Since the Board last met and on the back of the stronger-than-expected Q1 CPI data, its assessment of wage-price dynamics has shifted markedly. With underlying inflation rising above the top of the 2-3% target band to 3.7% in Q1, price pressures have broadened and are expected to be more persistent, with the RBA's liaison identifying that firms are increasingly confident in passing through higher prices to customers. Accordingly, the Bank's updated forecasts (to be released on Friday) have lifted the outlook for underlying inflation this year substantially, from 2.75% to 4.75%, with an easing back to 3% not expected before mid-2024.
Underpinning a higher inflation outlook is accumulating wage pressures, which are increasingly being reported to the RBA in its liaison program. In a tightening labour market, many firms are having to lift wages to attract and retain staff, and further falls in unemployment are expected. The RBA now expects the unemployment rate to fall to 3.5% (from 3.75% previously) by the end of the year and to hold at that level through 2023. All told, the RBA is now confident that the aggregate measure of wages growth in the Australian economy, the Wage Price Index (next due on 18 May), is on the rise and could lead to more durable inflation pressures. It is in that context that the RBA's policy outlook has shifted.
More rate hikes to come in 2022 and 2023
The Board now has an explicit tightening bias in place, with the final paragraph of the decision statement noting that in order to contain inflation "a further lift in interest rates over the period ahead" will be required. Importantly, Governor Lowe said in the post-meeting press conference that the forecast for underlying inflation to run above the top of the target band through to mid-2024 is despite using an assumption where the cash rate rises to around 1.5% to 1.75% by the end of the year and to around 2.5% by the end of 2023.
Given this, there is a strong possibility the RBA will look to frontload this tightening cycle, following the likes of the Fed, BoC and RBNZ. This could lead to a larger hike (40-50bps) at the next meeting in June, particularly if the WPI data comes in stronger than expected. A more complete assessment of the evolution of the RBA's hiking cycle will be possible after it publishes its quarterly Statement on Monetary Policy on Friday.
