• RBA raises key interest rate to 2.85%, signals more hikes to come

• The central bank lowered its economic outlook in response to higher rates

• RBA expects inflation to peak at around 8% later this year

• Expect more rate increases to come

The Reserve Bank of Australia (RBA) has increased the official interest rate by 0.25 percentage points, the seventh straight rise in a galloping tightening cycle aimed at curbing inflation now expected to peak higher. This means the overnight cash rate has leapt from 0.1% to 2.85% since early-May, the fastest tightening cycle in almost 30 years. The latest increase takes the cash rate to its highest level since April 2013. It also increased the interest rate on Exchange Settlement balances by 25bps to 2.75%.

The central bank had surprised many in the markets last month by downshifting to a quarter-point rate hike following four consecutive moves of 50 basis points, citing an already substantial rise in rates. Rates have already risen by 275bps since May and the RBA had wanted to slow down and see how the drastic tightening was affecting consumer spending, against a backdrop of heightened global uncertainty.

There were no surprises in the accompanying statement, which stated that interest rates have materially risen since May. In fact, at 2.85%, the OCR is 205bps above pre-pandemic levels.

The RBA was the first central bank among developed nations to break with outsized interest rate hikes, warning that households were already under pressure with rate rises so far.

RBA Governor Philip Lowe said in a statement that the central bank's board was seeking to return inflation to the target range while keeping the economy on an even keel. He said that "the path to achieving this balance remains a narrow one and it is clouded in uncertainty”, adding that the board recognises monetary policy operates with a lag.

The Board “expects to increase interest rates further over the period ahead. It is closely monitoring the global economy, household spending and wage and price-setting behaviour. The size and timing of future interest rate increases will continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that”.

Nonetheless, the RBA has guided that further economic data will be closely watched. The size and timing of future rate hikes will be determined by incoming data and the outlook for inflation and labor market.

The central bank expects inflation to “further increase” over the months ahead and peak at around 8% this year. CPI inflation is forecast to be around 4.75% over 2023 and a little above 3% over 2024. GDP growth forecast was “revised down a little” to 3% this year, 1.50% (from 1.8%) in 2023 and 1.5% (from 1.7%) in 2024. Unemployment rate is forecast to rise gradually from current 3.5% to a little above 4% in 2024 as economic growth slow.

Expect more rate increases to come

The next meeting is on 6 December, and that will be the final meeting of 2022. We are pencilling in another 25bps hike, which will take the OCR to 3.10%. Given that the Board chose not to respond to the inflation shock with more than 25bps we can only conclude that as rates continue to rise the increments will be 25bps. It now seems that the Board is prepared to await the impact of the series of hikes at that risk of embedding an inflation psychology in the system which would eventually require a much more damaging policy response. Going forward we now expect 25bps increments in February; March and May 2023.

Source: BIMB Securities Research - 2 Nov 2022