If you really want to understand the latest RBA rate hike, Sophia Rodrigues offers a savvy independent analysis of the drivers behind it, and looks ahead

The Reserve Bank of Australia lifted the cash rate by 25bps to 4.10% this week, delivering two back-to-back interest rate increases and surprising on two counts.

--The decision was very close, with the board securing a close 5-to-4 majority.
--Governor Michele Bullock’s comments at the media conference were more hawkish than expected.

The former reduced the odds of another hike in May, while the latter ensured the market probability didn’t decrease significantly. The money market has taken a mid-path, pricing around 40% chance of a third consecutive cash rate hike at the May meeting.

Still, elevated inflation means mortgage holders might have to prepare for one or more further interest rate increases, unless the Middle East conflict persists and poses downside risks to global growth.

Economists are largely sticking to another hike in May as their base case.

Anchoring inflation expectations

This week’s decision was aimed entirely at ensuring inflation expectations remain anchored.

“The RBA sent the signal by deed more than word,” writes Stephen Walters, chief economist at Optimal Economics

He acknowledges a spike in oil prices may slow growth and dent confidence, but the more serious and persistent impact is the wave of inflation it triggers.

“In this environment, the RBA wants to re-anchor price expectations by sending a strong signal that interest rates will keep rising as needed.”

Indeed, Governor Bullock’s language was unusually hawkish at the media conference. 

Bullock emphasised the rate hike was delivered in response to domestic inflationary pressures arising from stronger demand versus the economy’s capacity.

“Higher petrol prices will add to inflation, but they are not the reason for today’s decision,” Bullock said.

Her language focused on the risks ahead as the RBA judged the inflationary impact of higher fuel prices is likely to be greater than its dampening impact on growth. 

“Inflation was already too high, reflecting the fact that demand is outstripping supply. Higher fuel costs will not slow demand enough on their own to address this.”

Governor Bullock recently returned from an overseas trip where she met her global counterparts, so her focus on inflation risks likely reflects the conversations there.

Close vote

The 5-4 vote surprised many, mainly because it was closer than expected.

Westpac chief economist Luci Ellis had flagged the possibility of a split decision, but the 5-4 vote was an “even finer majority” than she thought.

One way to think about the close split is that it shows Bullock’s resolve to act and act sooner. 

It wouldn’t be a stretch to assume Bullock could have easily voted on either side, and that would have been the meeting outcome. To go ahead with a hike with such a close split signals urgency to get inflation back at the target.

In other words, the RBA has a very low tolerance for extending the timeframe to get inflation into the target band. The projections in the February Statement on Monetary Policy pointed to inflation being outside the target for six years.

“That does weigh on the board’s thinking,” Bullock said in February, explaining it was the reason for the hike that month.

The board is “not happy with what the inflation rate is at the moment and what the prospects for getting it back down are,” she said then.

If the board was not happy then, it follows that it has even less tolerance now, given inflation risks have tilted further to the upside since then.

Third consecutive hike

The question, going ahead, is whether the board has an appetite to lift the cash rate again in May and make it three back-to-back hikes.

Challenger’s chief economist Jonathan Kearns explains the 5-4 hike can be interpreted in two ways.

The hike simply brought forward a move four members would have supported in May, meaning a pause in May is possible if just one more member agrees. 

Alternatively, since the RBA’s February forecasts implied at least three hikes even before rising oil prices, and only two have occurred, another increase is likely, and the RBA appears unwilling to delay.

On balance, Kearns believes a May hike is possible, though much will depend on inflation and employment data before then, and the implications of developments in the Middle East for inflation and growth.

Westpac’s Ellis notes the RBA remains concerned the domestic economy is too tight and demand is growing too quickly, and its stance reflects pessimistic assumptions on population and productivity, she said.

“While this remains the RBA’s view and inflation above target, rate hikes will remain on the table and our base case remains for a May rate hike,” she said.

Betashares’ chief economist David Bassanese thinks of a worst-case scenario where prolonged Middle East conflict drives sustained energy price rises, forcing aggressive RBA hikes, even at the cost of a recession and unemployment above 5%.

The best case, in his view, is a quick resolution and low March quarter inflation, which would remove the need for a May hike.

His base case is that Middle East hostilities will end by the May meeting and oil prices will fall materially from the current levels, but a hike would still be needed.

“My view is that this would still not be enough to stop the RBA hiking again in May, given the prospect of a further uncomfortably high inflation result for the March quarter, not helped by the elevation in energy costs over recent weeks,” he said.

HSBC’s chief economist Paul Bloxham believes policy choices in Australia have narrowed significantly.

“Just as the RBNZ Governor did during the last inflation surge in New Zealand in 2021, and Treasurer Keating noted after the 1990s recession began, the RBA may now have to be clear that a recession may be what is needed to get inflation sustainably back to target,” he said.

“At a minimum, Australia almost certainly now requires a downturn to dis-inflate the economy. Will it be a recession? Time will tell,” he added.