The Reserve Bank of Australia (RBA) has announced an interest rate hike of 25 basis points, as expected. Rates have increased to 2.85% from the previous 2.6%, thus reaching their highest level in nine years, specifically since April 2013. The entity also increased the interest rate on foreign exchange settlement balances by 25 basis points, to 2.75%.
As in most countries, inflation in Australia is too high. Until September, the CPI rate was 7.3%, the highest in more than three decades. Global factors explain much of this high inflation, but strong domestic demand relative to the economy’s ability to meet it also plays a role. Bringing inflation back on target requires a more sustainable balance between demand and supply.
A further increase in inflation is expected in the coming monthsand is expected to peak at about 8% by the end of this year. Inflation is then expected to ease next year due to the ongoing resolution of global supply problems, recent declines in some commodity prices, and weaker demand growth. Medium-term inflation expectations remain well anchored, and it is important that they remain so. The Bank’s central forecast is for inflation to be around 4.75% in 2023 and slightly above 3% in 2024.
The Australian economy continues to grow strongly and national income is buoyed by a record level of terms of trade. Economic growth is expected to moderate over the next year as the global economy slows, the rebound in services spending continues and household consumption growth slows due to tightening financial conditions. The RBA’s central forecast for GDP growth has been revised down slightly, with growth expected to be around 3% this year and 1.5% in 2023 and 2024.
The labor market remains very tight, with many companies having difficulty recruiting workers. The unemployment rate remained at 3.5% in September, around the lowest rate in almost 50 years. Both vacancies and job advertisements are at very high levels, although job growth has slowed in recent months as excess capacity in the labor market has been absorbed. The central forecast is for the unemployment rate to remain around its current level for the next few months, but gradually rise to slightly above 4% in 2024, as economic growth slows.
Wage growth continues to recover from the low rates of recent years, although it is still lower than in many other advanced economies. A new upturn is expected due to the rigidity of the labor market and the increase in inflation. Given the importance of avoiding a spiral of wages and prices, the Council will continue to pay close attention both to labor cost developments and to the future pricing behavior of companies.
Price stability is a prerequisite for a strong economy and a sustained period of full employment. Therefore, the Council’s priority is to bring inflation back to the 2-3% range over time. To do this, it seeks to maintain the balance of the economy. The path to achieve this balance remains narrow and clouded by uncertainty.
One source of uncertainty is the outlook for the world economy, which has deteriorated in recent months. Another is how household spending in Australia responds to tighter financial conditions. The Council acknowledges that monetary policy is running late and that the full effect of higher interest rates is yet to be felt in mortgage payments. Rising interest rates and inflation are putting pressure on the budgets of many households. Consumer confidence has also fallen and house prices have fallen after previous big rises. In the other direction, people are finding work, earning more work hours and receiving higher wages. Many households have also built up large financial reserves, and the savings rate remains higher than it was before the pandemic.
The Council has raised interest rates significantly since May. This has been necessary to establish a more sustainable balance between demand and supply in the Australian economy to help bring inflation back on target. The Council expects to continue raising interest rates in the future. It is closely monitoring the global economy, household spending, and wage and pricing behavior. The size and timing of future interest rate hikes will continue to be determined by data and the Council’s assessment of the outlook for inflation and the labor market. The Council remains determined to bring inflation back on target and will do what is necessary to achieve this.
Source: Fx Street