The RBA hiked the cash rate by 25bps to 3.85% in a unanimous decision by the Monetary Policy Board at today's meeting in Sydney. Inflation moving further above the 2-3% target band reinforced the RBA's concerns that capacity pressures are arising amid robust demand and labour market conditions, prompting today's hike. And more are likely to follow. The RBA lifted its inflation forecasts - core inflation is expected to remain above the midpoint of the band over the next couple of years - leading markets to price in price in two further rates hike this year - one more than previously expected. If delivered, that would reverse the RBA's three rate cuts from 2025.
Today's meeting proved to be more hawkish than markets had expected - despite a rate hike being widely touted. Markets came into the meeting pricing in two rate hikes this year, but new forecasts published in the Statement on Monetary Policy - that factored in that outlook for interest rates - still showed materially higher inflation was now the base case for the RBA. Forecast inflation this year was lifted from 3.2% to 3.6% in headline terms and from 2.7% to 3.2% on a core basis. Upward revisions were also seen in the forecasts for 2027 (2.7% from 2.6% for both measures), with inflation still remaining slightly above the midpoint of the band into 2028 (2.6% headline and core). Furthermore, the forecasts also signalled a stronger near-term growth outlook and tighter labour market conditions are now expected by the RBA.
In response, markets now expect a total of three rate hikes this year - the next two most likely going through at the quarterly 'forecast' meetings in May and August. At the post meeting press conference, Governor Bullock said the overall strategy of returning inflation to target without coming at the expense of its full employment objective was still guiding the Board - pointing to a gradual tightening cycle this year. That said, the reacceleration in inflation over the back half of last year has clearly surprised the RBA, as has the strength in the economy and the labour market.
Last week's December quarter CPI data confirmed a further overshoot of inflation to the target band: headline inflation lifted to 3.6% year-on-year and the core rate rose to 3.4% year-on-year. Governor Bullock attributed part of the inflation overshoot to temporary price increases (such as electricity rebates unwinding and holiday travel) but also said that inflationary pressures in other parts of the basket (services and new dwellings) were more likely to persist.
Elevated inflation indicated to the Board more generally that the pick-up in private demand from household spending and business investment was testing the supply capacity of the economy after years of weak productivity growth. That was backed up by GDP growth surprising to the upside at 2.1%Y/Y in Q3, while the labour market had remained tighter than expected - the unemployment rate averaged 4¼% in Q4, defying the RBA's November forecast to rise to 4.4%.
On Friday (0930 AEDT), Governor Bullock and other RBA officials are set to appear for a parliamentary testimony hearing. The next RBA monetary policy meeting is scheduled for 16-17 March.
