Australia’s central bank signaled further policy tightening ahead after unexpectedly raising interest rates by a quarter-percentage point on Tuesday, sending the currency and bond yields surging.
(Bloomberg) — Australia’s central bank signaled further policy tightening ahead after unexpectedly raising interest rates by a quarter-percentage point on Tuesday, sending the currency and bond yields surging.
The Reserve Bank increased its cash rate to 3.85%, the highest level since April 2012, in a decision predicted by only nine of 30 economists. Money markets rapidly revised up expectations for further moves and are now pricing in a rate of just under 4% by September, from around 3.6% before today’s decision.
The unexpected hike from a pause in April comes shortly after an independent review of the RBA recommended overhauling the current board set up and strengthening its communications. Treasurer Jim Chalmers is due in the next month or two to announce whether he will extend Governor Philip Lowe’s term or install someone new.
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“The surprise hike suggests a shift in the RBA’s assessment of the tradeoff between growth and inflation,” said James McIntyre at Bloomberg Economics in Sydney. “An easing in offshore banking tensions and an upward revision to migration at home suggest greater comfort with downside growth risks.”
Australian government bonds slid after the decision as the prospect of higher rates curbed demand for government debt. The selloff pushed three-year yields 22 basis points higher, boosting the appeal of the Australian dollar, which strengthened more than 1%. The benchmark share index dropped 1.1% as higher borrowing costs may slow profit growth.
Even after today’s hike, Australia still lags global counterparts in its policy response to higher prices. It has raised rates by 3.75 percentage points, compared with 5 in New Zealand and 4.75 in the US.
Both the Federal Reserve and the European Central Bank are expected to raise rates again at meetings this week and New Zealand’s central bank is forecast to do so later this month.
“Today’s move is a small step, against market expectations, that closes the policy gap with the likes of NZ, US,” said Jason Wong, currency strategist at Bank of New Zealand Ltd. “Bond market reaction of higher rates across the curve looks entirely appropriate, with the RBA needing more work to do to bring inflation down.”
Lowe has been under pressure over his communication after holding on too long to his pandemic-era message that rates were unlikely to rise before 2024. The RBA began hiking aggressively from May 2022 and then pivoted earlier than global counterparts to smaller increases.
“The RBA are seen as pretty idiosyncratic and have been more choppy in their tone vs the Fed who have been on a much more consistent messaging path,” said Laura Fitzsimmons, executive director of macro rates and FX sales at JPMorgan Chase & Co. in Sydney.
Su-Lin Ong, chief economist at Royal Bank of Canada, said the tweaks in the statement imply a change to the RBA’s reaction function from just a month ago, referring to a new phrase in the final paragraph about returning inflation to its 2-3% target within “a reasonable timeframe.”
“This phrase suggests a quicker return to within target inflation before mid-25 may be desirable even if the economy and labor market is weaker,” she said.
Lowe’s statement provided updated quarterly forecasts that will be released in full on Friday. They were little changed from three months ago and showed inflation easing to 4.5% this year — from 7% in the first quarter — and down to 3% in mid-2025; gross domestic product is seen advancing 1.25% this year.
Lowe pointed to unit labor costs rising “briskly” while productivity growth is subdued, adding the board “remains alert” to the risk of a price-wage spiral.
The RBA chief will give a speech in Perth at 9.20 pm Sydney time when he will likely further explain the board’s thinking. A short question-and-answer session will follow the address.
“Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe,” Lowe said in today’s statement. “The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.”
–With assistance from Tomoko Sato, Ruth Carson and Matthew Burgess.
(Updates market reaction.)
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