In considering the policy decision, members observed that inflation in Australia had increased significantly and that the outlook for inflation had been revised higher over the prior month. Inflation was expected to increase further, before declining back towards the top of the 2 to 3 per cent range in 2023.
Global factors, including COVID-19-related disruptions to supply chains and the war in Ukraine, accounted for much of the increase in inflation.
However, domestic factors were increasingly playing a role. Capacity constraints in some sectors and the tight labour market were contributing to upward pressure on prices. The east coast floods earlier in the year had also affected some prices.
Higher electricity and gas prices and recent increases in petrol prices meant that, in the near term, inflation was likely to be higher than expected a month earlier.
As the global supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation was expected to moderate to the top of the target range. Members observed that these forecasts incorporated a technical assumption of further increases in the cash rate.
Members discussed the resilience of the Australian economy. Growth had been supported by household and business balance sheets that are generally in good shape, an upswing in business investment and the large pipeline of construction work to be completed.
Macroeconomic policy settings were also supportive of growth and higher commodity prices had provided a boost to national income. The terms of trade were at a record high.
The resilience of the economy was most evident in the labour market. Employment had grown significantly in preceding months and the unemployment rate was at multi-decade lows. Job vacancies and advertisements were at high levels and further declines in unemployment and underemployment were expected.
Information from the Bank’s liaison program continued to indicate that wages growth would increase from the low rates of recent years as firms compete for staff in a tight labour market.
Members agreed that there was a material risk that inflation would not return to the target if current policy settings were maintained.
The very low level of interest rates that had been put in place to support the economy during the pandemic was no longer appropriate.
The increase in the cash rate at the previous meeting had been accompanied by communication that further increases in interest rates would be needed, with the timing and extent of the increases to be determined by incoming information and the evolving balance of risks. Recent information showed that inflation was high and rising, and there had been further upside surprises over the prior month.
Two options for the size of the cash rate increase were considered: raising the cash rate target by 25 basis points or by 50 basis points. Members noted that both options would leave the cash rate below 1 per cent, which would still be highly stimulatory, and that further increases would be required.
The main argument for an increase of 50 basis points was that the level of interest rates was still very low for an economy with a tight labour market and facing a period of higher inflation.
Additionally, the inflation mindset in Australia appeared to be shifting. Firms had become more willing to pass on cost increases to consumers and, in a tight labour market, employees were demanding higher wages as compensation for higher living costs.
In such an environment, there is a heightened risk of persistently high inflation, especially if expectations of higher inflation become entrenched. If that were to occur, the task of returning inflation to the target would become more difficult and come at a higher cost in terms of lower levels of economic activity and employment.
Raising the cash rate by 50 basis points at the current meeting would help to mitigate this risk.
Members considered whether an increase of 50 basis points could add to the community’s concerns that inflation was likely to stay high. While this was a risk, the Bank could communicate that inflation was expected to return to the target over time and that the Board was committed to this objective.
The argument for an increase of 25 basis points was that a sequence of 25 basis point moves represented a steady approach to withdrawing monetary policy stimulus and that this was appropriate in an uncertain environment.
Members observed that if the cash rate were to be increased by 25 basis points at each meeting over the remainder of 2022, the cash rate would be 2.1 per cent by the end of the year. In a historical context, this would be quite a rapid tightening.
While some central banks had been increasing policy rates in 50 basis points increments, these central banks meet less frequently than the Reserve Bank Board.
Members also noted that, over the preceding couple of decades, increases in the cash rate had typically occurred in 25 basis point increments. The previous instance of the Board having increased the cash rate by 50 basis points was in February 2000.
Members also considered the evolving risks to household consumption, including how households would adjust their spending in response to higher prices and interest rates, and the impact of higher interest rates on the housing market.
Housing prices had declined in some markets over preceding months, but remained more than 25% higher than prior to the pandemic, thereby supporting household wealth and spending.
Further, many households had built up large financial buffers during the pandemic and the household saving rate was very high. The central scenario, which was conditioned on the assumption of further rate rises, was for strong household consumption growth over the remainder of the year.
Given the current inflation pressures in the economy and the still very low level of interest rates, on balance, members agreed to a 50 basis point adjustment in the cash rate target. Members also agreed that further steps would need to be taken to normalize monetary conditions in Australia over the months ahead.
The size and timing of future interest rate increases will continue to be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market, including the risks to the outlook.
The Board remains committed to doing what is necessary to ensure that inflation in Australia returns to the target over time.
