RBA stuns Aussies, lifts cash rate by 50bps

Highlights

• The RBA has increased the cash rate target and interest rate on Exchange Settlement balances by 50 basis points each.
• The central bank has cited growing inflation as the primary reason behind the larger-than-expected rate hike.
• The Australian dollar leapt higher as soon as the interest rate decision was announced by the Reserve Bank.

The Reserve Bank of Australia (RBA) has once again rocked the boat with its interest rate decision by embracing a rate hike of 50 basis points. The latest decision was taken in the June monetary policy meeting and represents the second consecutive hike after May. The RBA had previously raised the cash rate by 25 basis points amidst soaring inflation and higher costs of living.

Though an interest rate hike was largely expected, the latest hike has surpassed expectations and gripped borrowers by the throat, as their repayment costs will rise significantly. The back-to-back rate hikes are happening for the first time in over a decade, as the central bank wants to move back to pre-pandemic settings. The central bank has also increased the interest rate on Exchange Settlement balances by 50 basis points to 0.75%.

Rising inflation has been the central bank’s prime concern over the last few months. Additionally, global factors have increased uncertainty, with shipment delays and supply-chain snags disrupting business activity.

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Why did the RBA turn hawkish?

Central banks across the globe are raising their interest rates to remove the additional stimulus provided to the economy during the pandemic. The RBA, much like many other central banks, had decreased the cash rate to near-zero levels during lockdowns. However, this additional stimulus is feeding into the already high level of inflation in the economy.

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Given the resilience of the Australian economy and the higher inflation, the RBA believes there is no need for extraordinary support now. Thus, it has decided to raise the interest rate by 50 basis points in the latest decision.  The big four banks had expected rate hikes of only as high as 40 basis points. One can say that the latest decision has been a shock for most.

In its previous monetary policy minutes, the Reserve Bank highlighted that it had three options for the size of the rate hike: 15 basis points, 25 basis points and 40 basis points. However, June’s rate hike has exceeded all the existing options, paving a tougher road ahead for mortgage holders.

What are the key pointers discussed in this month’s monetary policy meet?

• Domestic inflation lower than other economies: The RBA highlighted that Australia’s inflation rate is lower than the rate seen in most other advanced economies. However, the current inflation rate is higher than previously expected. Domestic factors such as capacity constraints in certain sectors and a tight labour market are putting pressure on prices.
• Further increases in inflation expected: Interest rate hikes would take some time to show full effect, and till then, inflationary pressures are expected to surge upwards. Higher fuel and electricity prices have become the nation’s biggest point of concern. These higher energy prices are likely to feed into ongoing inflation. However, inflation may decline back to the 2-3% range by next year.
• Household spending creating uncertainty: Household spending is the RBA’s area of concern in the current scenario. Higher power bills, soaring fuel prices, and an uptick in the prices of consumer discretionary goods could urge households to cut down on spending. Thus, economic activity is feared to remain on the downside in the coming months.

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What can be expected after the rate hike?

The rate hike is likely to curb consumer spending in the short term and further dampen the demand for loans. With higher rates, foreign investors might eye Australia as a potential market for their investments.

The higher returns offered by the country are expected to bring foreign capital. In exchange, these foreign investors could demand Australian currency. Thus, the Australian dollar could appreciate further. The same phenomenon was visible as the Australian dollar flew higher as soon as the rate hike announcement was made.

Except for high inflation, the RBA could have many more reasons to keep raising rates in the coming months.

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