The Reserve Bank of Australia Raised Rates Again & Kept More Tightening in Play

Another Rate Hike

The Reserve Bank Australia (RBA) had paused its tightening cycle in April in order to assess the impact of its actions, but restarted it last month, in a move that had startled markets. Going into this meeting, there was some uncertainty around the outcome, with baseline estimates calling for a hold.

On Tuesday, officials surprised again as they raised rates by another quarter percentage point, in order to provide "greater confidence" that inflation will return to the 2-3% target in a "reasonable timeframe" ^[1]. In pursuit of this goal, the central bank has delivered 400 basis points worth of hikes, since the May 2022 lift-off. The cash rate now stands at 4.1% and the highest levels in eleven year.

High Inflation

The Consumer Price Index (CPI) stood at 7% y/y in the first quarter and the smallest growth in nearly a year, moderating from the three-decades high of Q4 2022 (7.8%). The latest monthly data however, showed and uptick to 6.8% y/y in April, ending a series of declines.

The Reserve Bank Australia has acknowledged the progress and reiterated the view today that inflation has "passed its peak", but warned that it is "still too high" and will require "some time" before falling to the target range.

According to May's updated projections, RBA officials expect inflation to reach the top of the 2-3% target in mid-2025, which is a significant amount of time and later than they previously expected. ^[2]

Tight Labor Market

The Unemployment Rate rose to 3.7% in April, which was the highest since the beginning of 2023, but is still close to its 50 year lows. The central bank believes that conditions in the labor market remain "very tight", even though they have eased.

High inflation and tight labor market have led to a pickup in wage growth. Last month's data showed the Wage Price Index rising to 3.7% y/y in Q1 and the highest in nearly ten years, while the minimum wage in Australia will increase by 5.75% from July. ^[3]

Elevated wages make taming inflation harder, but it does not look like are high enough to risk a wage-inflation spiral.

Slower Economy

The Australian economy has generally been rather resilient, but had lost momentum in the fourth quarter, as the 2.7% y/y was the smallest in nearly two years. Policymakers admitted today that the economy "has slowed".

Last month they had slashed their GDP forecast to 1.25% at the end of 2023 (from 1.5% previously), expecting "below trend growth" ^[2]. Today, they repeated that the path to achieving a soft landing, remains "a narrow one".

More Firming in Play

The economy has slowed as a result of the cumulative effect of the aggressive tightening cycle and is expected to do so further, which calls for a less aggressive stance by the RBA.

Even though the labor market has loosened a bit, it remains tight and wages elevated. Inflation meanwhile has moderated, but stays way above the 2-3% target, which it is not projected to hit before mid-2025.

These call for restrictive stance and policymakers kept the door open to more rate increases today. They maintained guidance that that "some further tightening" in monetary policy "may be required" for bringing inflation down in a timely manner, but they will be data-dependent.

AUD/USD Reaction

The Australian central delivered another hike against baseline expectations for a hold tday, while keeping further tightening in play. AUD/USD jumped as result, extending its rebound from the 2023 lows at the end of May