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 for a second straight month and concluded the arguments were “finely balanced” before raising the cash rate to an 11-year high of 3.85%. The decision came as RBA forecasts show headline CPI isn’t seen reaching the top of its 2-3% target until mid-2025.
“Members noted that, although this was consistent with the bank’s mandate and objectives, it left little room for upside risks to inflation given that inflation would have been above the target for around four years by that time,” minutes of the May 2 board meeting showed Tuesday.
“Members also agreed that further increases may still be required, but that this would depend on how the economy and inflation evolve.”
Among potential upside risks, board members highlighted:
- the possibility that services price inflation remains sticky in Australia, inline with overseas experience
- strong population growth and low rental vacancy rates could see rents jump even more than the RBA’s elevated forecasts
- the possibility that productivity growth remained very weak leading to “uncomfortably fast” growth in unit labor costs
- that a prolonged period of high inflation may lead to a shift in price expectations and a change in price- and wage-setting behavior
“If these risks materialized, they would further delay the return of inflation to target with the prospect of a damaging shift in inflation expectations,” the minutes showed. “Further, members noted that the forecasts presented at the meeting were predicated on a technical assumption for the path of the cash rate that involved one further increase.”
Other reasons to resume hiking included strong economic data over April – a tight labor market and significant inflation pressures —while there was some easing in the stresses in global banking markets, the minutes showed.
The central bank further highlighted that a recent depreciation of the exchange rate and an increase in housing prices were in-part driven by the the decision to pause rate increases in April.
“The RBA appears increasingly concerned that weak productivity growth will result in inflation proving stickier,” said Gareth Aird at Commonwealth Bank of Australia, who views the current cash rate as the peak, while acknowledging the near-term risk of another hike. “We do not think the RBA will lift the cash rate again if the economic data prints in line or weaker than their forecasts.”
Even after May’s surprise hike, Australia has lagged global counterparts in its policy response to higher prices, having raised rates by 3.75 percentage points since May 2022, compared with New Zealand and the US, which pushed ahead with hikes in the face of banking turmoil and financial market volatility.
The RBNZ meets next week and is expected to deliver another quarter-point hike to take its cumulative increases to 5.25 percentage points.
A key reason behind RBA Governor Philip Lowe’s more cautious tightening is his desire to engineer a soft landing in Australia’s economy. That’s also part of the reason why economists believe the nation will avoid a recession.
The minutes reiterated that the RBA “is still seeking to traverse the narrow path” between cooling inflation and maintaining the economy’s momentum.
An hour before the minutes’ release, a private survey showed consumer confidence tumbled in May following the unexpected rate hike earlier in the month and a government budget that households found mildly disappointing.
Later this week, two key reports will provide further clues on the health of Australia’s labor market. Economists expect first-quarter Wage Price Index data on Wednesday to show a small acceleration in the pace of pay hikes at 3.6%, up from 3.3% in the final three months of 2022.
On Thursday, jobs data will show Australia’s unemployment rate stayed near a 50-year low of 3.5% in April even after 11 rate hikes.
(Adds comment from economist in ninth paragraph, consumer sentiment in 14th.)
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