19/07/2022 - 11:27

Waiting carries higher cost: RBA

19/07/2022 - 11:27

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Moves to lift the official cash rate show no sign of slowing, with the Reserve Bank indicating interest rates will need to be much higher to stop inflation.

Waiting carries higher cost: RBA
Homeowners should expect further rate hikes. Photo: Matt Mckenzie

Moves to lift the official cash rate show no sign of slowing, with the Reserve Bank of Australia indicating interest rates will need to be much higher to stop inflation.

The RBA’s board members had considered lifting rates by 25 basis points at its meeting earlier this month, before eventually settling on a 50 basis point increase, according to minutes of the meeting.

That took the cash rate to 1.35 per cent.

But interest rates were very low for a country with a tight jobs market and inflation over the bank’s 3 per cent target, the notes said.

It would be key that inflation expectations remain steady.

Long term expectations were still anchored, the board said in the minutes.

“If medium-term inflation expectations were to adjust upward, the task of returning inflation to the target would be more difficult and would come at a higher cost in terms of activity and employment,” the bank said.

One key measure of exactly how high the RBA will go is to judge what is called the neutral rate of interest.

That’s the inflation-adjusted interest rate which means the bank’s policy is neither pushing the economy faster or slower.

Adding inflation expectations to that real interest rate will give an indicator of where the RBA’s cash rate should be over the medium term.

“(The) current level of the cash rate is well below the lower range of estimates for the nominal neutral rate,” the minutes said. 

“This suggests that further increases in interest rate will be needed to return inflation to the target over time. 

“(The) neutral rate framework indicates that if inflation expectations rise, the level of nominal interest rates required to return inflation to the target will be higher than otherwise.”

While the bank cautioned that mechanism was a guide only, it does give an indication that rates may need to rise further than previous predicted.

There were three data points in the minutes that were particularly notable.

About 60 per cent of businesses in the bank’s liaison program expected wages growth to rise in the year ahead, with a recent decision by the Fair Work Commission to lift the minimum wage contributing.

Companies were also more willing to pass through cost increases to consumers, the RBA said.

And growth in borrowing in May had been at its fastest pace in more than a decade, indicating borrowers had not yet been spooked by warnings of rate rises.

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