Australia elevates key rate to 10-year high

Reserve Bank says tightening will go on

Australia’s central bank raised interest rates by a quarter-percentage point and said further tightening will be needed, sending the currency and government bond yields higher.

At its first meeting of the year, the Reserve Bank lifted the cash rate to 3.35%, the highest level since September 2012, in a widely-anticipated decision. It was the ninth consecutive hike since policymakers embarked on their tightening cycle in May.

“The board expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target,” RBA Governor Philip Lowe said in a statement. His removal of last year’s qualifier that the bank wasn’t on a pre-set rate path fuelled the market’s response.

The Australian dollar jumped to trade at 69.40 US cents, while three-year bond yields climbed 15 basis points to 3.25% and stocks erased gains to drop 0.5%.

“The statement definitely has a hawkish tinge to it,” said Su-Lin Ong, chief economist at RBC Capital Markets. “The emphasis on returning inflation to target is very clear. And that takes front and centre of the statement over any kind of concerns in terms of a moderation in activity.”

Australia has lagged international counterparts in its policy response to higher prices, having raised rates by 3.25 percentage points, compared with 4 in New Zealand and 4.5 in the US.

The RBA’s slower pace reflects Lowe’s efforts to bring the economy in for a soft landing. The Federal Reserve is expected to keep pushing higher following a strong employment report.

Lowe’s statement yesterday is a sharp contrast from December when the board discussed a possible pause in tightening and traders responded by repricing the rate outlook.

Money markets imply a peak rate of 3.9% by mid-2023, higher than economists’ forecast of 3.6%, as inflation remains well above the RBA’s 2-3% target. In yesterday’s statement, the bank said it didn’t expect to get back to the top of that range until mid-2025.

The Reserve Bank of New Zealand’s estimated terminal rate is 5.5%, while the Fed’s December forecasts showed a median estimate of about 5.1%. The RBA doesn’t forecast a future rate path.

“The board recognises that monetary policy operates with a lag,” Lowe said yesterday. “There is uncertainty around the timing and extent of the expected slowdown in household spending.”

Working in Lowe’s favour is a housing market where the pace of decline has begun to ease, raising the prospect of an orderly correction. Employment growth has also cooled in recent months while consumer spending is showing early signs of slowing.

Yet inflation remains uncomfortably high, with core prices in the fourth quarter surging 6.9% — exceeding the RBA’s forecast of 6.5% — and stronger than the impulse seen in the US and UK.

That helps explains why economists at Deutsche Bank AG and Goldman Sachs Group Inc expect the cash rate to surpass 4% this year. Australia & New Zealand Banking Group Ltd and Westpac Banking Corp see two more hikes to 3.85%.

The RBA may not agree with those aggressive expectations as it reckons inflation will slow this year.

Lowe has acknowledged the path to cooling inflation while preserving employment gains is a “narrow” one. But his determination to do so is part of the reason why economists expect Australia will avoid a recession.

“Household balance sheets are also being affected by the decline in housing prices,” Lowe said in his statement.