At its meeting today, the Board decided to increase the target cash rate by 50 basis points to 85 basis points. It also increased the interest rate on foreign exchange settlement balances by 50 basis points to 75 basis points.
Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than expected. Global factors, including COVID-related supply chain disruptions and the war in Ukraine, largely explain this rise in inflation. But domestic factors are also playing a role, with capacity constraints in some sectors and the tight labor market contributing to upward pressure on prices. The floods at the start of the year also affected some prices.
Inflation is expected to rise further, but then decline back to the 2-3% range next year. Higher electricity and gas prices and recent increases in gasoline prices mean that in the near term, inflation is likely to be higher than expected a month ago. As global supply issues are resolved and commodity prices stabilize, even at a high level, inflation should moderate. Today’s increase in interest rates will help inflation return to target over time.
The Australian economy is resilient, growing 0.8% in the March quarter and 3.3% for the year. Household and business balance sheets are generally healthy, a recovery in business investment is underway and a large pipeline of construction work remains to be completed. Macroeconomic policies support growth and national income is boosted by rising commodity prices. The terms of trade are at an all time high.
The labor market is also strong. Employment has increased significantly and the unemployment rate is 3.9%, the lowest rate in nearly 50 years. Vacancies and job vacancies are at high levels and a further decline in unemployment and underemployment is expected. The Bank’s corporate outreach program continues to point to an increase in wage growth from the low rates of recent years as companies compete for staff in a tight labor market.
The evolution of household spending is a source of uncertainty about the economic outlook, given the growing pressure on Australian household budgets from rising inflation. Interest rates are also rising. House prices have fallen in some markets in recent months, but remain more than 25% higher than before the pandemic, supporting household wealth and spending. The household savings rate also remains higher than it was before the pandemic and many households have built up significant financial reserves. While the central scenario is one of strong household consumption growth this year, the Council will pay close attention to these various influences on consumption when assessing the appropriate monetary policy framework.
The Board will also pay particular attention to the global outlook, which remains clouded by the war in Ukraine and its effect on energy and agricultural commodity prices. Real household incomes are under pressure in many economies and financial conditions are tightening as central banks withdraw monetary policy in response to widespread inflation. There are also lingering COVID-related uncertainties, particularly in China.
Today’s interest rate hike by the Board is another step in the withdrawal of the extraordinary monetary support that has been put in place to help the Australian economy during the pandemic. The resilience of the economy and rising inflation mean that this extraordinary support is no longer needed. Given the current inflationary pressures in the economy and the still very low level of interest rates, the Board decided today to advance by 50 basis points. The Council expects to take further steps in the process of normalizing monetary conditions in Australia over the coming months. The magnitude and timing of future interest rate increases will be guided by incoming data and the Board’s assessment of the outlook for inflation and the labor market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.
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