What will the RBA do next?

Australia’s central bank is prepared to pause its tightening cycle or return to larger interest-rate increases if the economy requires it, according to minutes of the Nov. 1 policy meeting when it lifted the benchmark by a quarter percentage point.

The Reserve Bank’s board considered two options –- 25 basis points or 50 — at that meeting, deciding there was a stronger case for the former given the full effect of its rapid-fire hikes since May still lay ahead.

“The arguments for a 25 basis point increase rested largely on the fact that the cash rate had been increased materially in a short period of time and that there were lags,” the minutes released Tuesday showed. “Members also discussed the value of the board acting in a consistent manner,” having pivoted to smaller increases a month before.

The RBA reiterated that rates “are not on a pre-set path” and that the size and timing of future hikes will be determined by incoming data and the outlook for inflation and employment. That provides the board with maximum flexibility to manoeuvre in the current cycle.

“The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome,” the minutes showed.

The RBA has raised rates by 2.75 percentage points in seven months as it grapples with the fastest inflation in more than three decades. The central bank was, however, the first to break with the global trend of outsized moves, when it downshifted to quarter point hikes at the past two meetings.

That’s heralded another change, with Governor Philip Lowe expected to draw out the tightening cycle with smaller increments over a longer period to reinforce the RBA’s commitment to returning inflation to its 2-3% target. Consumer-price growth is predicted to peak at 8% late this year.

The RBA acknowledged that soaring borrowing costs had taken the heat out of the country’s soaring housing market with demand for mortgages falling too. Members highlighted that given the cumulative increase in rates prior to the Nov.1 meeting, scheduled mortgage payments as a share of household income were expected to increase to the highest since 2010.

Still, the central bank reiterated that further rate increases were likely to be needed in the period ahead as inflation was “too high.” A risk to the inflation outlook over the medium term was the possibility of a price-wage spiral, leading in more persistent inflationary pressures.

Economists and financial markets expect the RBA to raise rates by another quarter-point at next month’s meeting, taking the cash rate to 3.1%.

RBA members also reviewed the bank’s use of forward guidance and discussed its future approach.

While the board agreed that the stronger forward guidance had worked to lower funding costs and support the economy in the early days of the pandemic, it subsequently presented “substantial communication challenges.”

Based on the review, the board decided that its approach to forward guidance will henceforth be based on the following considerations:

  • Where forward guidance is appropriate, ordinarily it will be “qualitative in nature”
  • Forward guidance on interest rates will not always be provided
  • The board does not intend to publish its own forecasts of the expected policy path
  • When policy rates are at, or near, the effective lower bound, a stronger form of forward guidance will be considered.

From MPA

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