The Reserve Bank of Australia Delivered its Biggest Rate Hike in More than 20 Years

Hawkish Shift

The Reserve Bank of Australia (RBA) had for a long time been behind most of its major peers, in normalizing the ultra-loose monetary policies which were implemented in the wake of the COVID-19 pandemic to combat the economic fallout.

During this year however, the central has been turning hawkish and things have been moving fast over the last couple of months. In early May, it delivered its first interest rate hike in more than 10 years (by 25 basis points), ignoring the then upcoming Australian general elections, which some believed could have prevented it from action.

Today, the RBA doubled down on hawkish pivot and raised rates by 50 basis points (to 0.85%), which was more than the baseline expectation and the largest upwards move since February 2000.

Furthermore, the Board expects to take "further steps in the process of normalising monetary conditions in Australia over the months ahead" and reiterated its commitment to do "what is necessary to ensure that inflation in Australia returns to target over time". ^[1]

High Inflation & Resilient Economy

Similar to other countries - although to a lesser extent - Australia is troubled by high inflation, due to the pandemic and the war in Ukraine, which has sparked this shift towards monetary tightening.

Headline Consumer Price Index (CPI) had surged 5.1% in the first quarter (year-over-year), with the central bank expecting it to rise up to 6% in the second half ^[2]. In today's statement, it noted that inflation "has increased significantly".

Despite the outside shocks, the Australian economy seems to be in good shape, as we have commented before, with the RBA saying today that it is "resilient". Last week's data showed that GDP slowed in the first quarter, having grown by 3.3% year-over-year from 4.4% (revised), but this is still a solid performance.

More to it, Australian Unemployment was at 3.9% in April, which is the lowest level in nearly 50 years, while the May report is expected next week.

The combination of high inflation and a resilient economy is supportive of the central bank's aggressive tightening, although there are uncertainties.

RBA vs US Fed

The US Federal Reserve has also delivered 75 basis points worth of interest rate hikes this year and has pointed to half percentage point moves over the next two meetings. After the last decision in May, it seemed to be turning a bit conservative, which made sense given the GDP contraction in Q1 and the fact that inflation has been showing signs of easing.

Last week however, we saw an effort by various officials to reassert the bank's hawkishness and resolve to bring inflation down. Vice-Chair Ms Brainard for instance, said that "Right now, it's very hard to see the case for a pause," and added that "We've still got a lot of work to do to get inflation down to our 2% target" in a CNBC interview. ^[3]

The policy differential between the two central banks has now diminished greatly, but we may get a better sense of the Fed's intentions past July, in next week's decision, which will also include the updated staff projections.

AUD/USD Reaction

The pair spiked after the aggressive 50 bps hike by the RBA, but broader sentiment works against it and it trades in the red. Its three week advance was contained by the 200Days EMA on Friday, whereas the new one has started on the back foot.