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Reserve Bank shocks with hawkish 50bp increase

The Reserve Bank of Australia (RBA) has decided to increase the cash rate target by 50 basis points to 85 basis points.

The central bank also raised the interest rate on exchange settlement balances by 50 basis points to 75 basis points.

At its meeting today, RBA governor Phillip Lowe said inflation in Australia has increased significantly.

Lowe said: "While inflation is lower than in most other advanced economies, it is higher than earlier expected. Global factors, including Covid-related disruptions to supply chains and the war in Ukraine, account for much of this increase in inflation."

"But domestic factors are playing a role too, with capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices. The floods earlier this year have also affected some prices."

Inflation is expected to increase further but Lowe believes it will decline back towards the two-three percent range next year.

"Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago," Lowe said.

"As the global supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Today's increase in interest rates will assist with the return of inflation to target over time."

Following the RBA's announcement, CPA Australia said today's interest rate decision highlighted a major flaw in the way Australia reports inflation.

CPA Australia senior manager of business policy Gavan Ord said: "In reaching today's decision, the RBA has relied on CPI figures for the March quarter. These are the same figures it relied on to raise interest rates by a quarter of a percent in May and will be the same figures it relies on at its July meeting."

"Because Australia only reports CPI data quarterly, we have a limited understanding of the impact May's interest rate rise had on inflation. By contrast, the US Federal Reserve, the European central bank, the Bank of Japan and the Bank of England, all have access to data within weeks of making a decision."

Ord added that current indicators pointed toward inflation having a continued sharp upward trajectory and that the RBA couldn't afford to wait until the June quarter CPI figures.

Subsequently, CPA Australia has called on the government to increase the frequency of consumer price index reporting to monthly.

After running down Australia's inflation woes, Lowe went on to say that the Australian economy is resilient, he signalled the 0.8% growth in the March quarter and 3.3% growth over the year.

"Household and business balance sheets are generally in good shape, an upswing in business investment is underway and there is a large pipeline of construction work to be completed," Lowe said.

"Macroeconomic policy settings are supportive of growth and national income is being boosted by higher commodity prices. The terms of trade are at a record high."

However, Lowe held that one source of uncertainty about Australia's economic outlook was how household spending evolved given the increasing pressure on households' budgets from higher inflation and interest rate increases.

Finder head of consumer research Graham Cook said this cash rate hike alone could cost the average homeowner almost $2000 a year.

"The average homeowner will see their monthly repayments jump by $159 - equivalent to $1,907 per year from this increase alone, with more to come," Cook said.

Equally troubling, Finder showed that wage growth continue to lag inflation.

"In the 12 months to March 2022, the consumer price index increased by 5.1%, while the wage price index increased by 2.4%," stated a Finder survey.

Moody's Analytics economist Harry Murphy Cruise said that inflation will continue to outpace wage growth, but only in the short term.

"In the short term, prices will continue to outpace wages, although we can expect that to flip as supply constraints ease and wages play catchup," he said.

Likewise, Lowe held that one source of uncertainty about Australia's economic outlook was how household spending evolved given the increasing pressure on households' budgets from higher inflation and interest rate increases.

Lowe continued: "Real household incomes are under pressure in many economies and financial conditions are tightening, as central banks withdraw monetary policy support in response to broad-based inflation. There are also ongoing uncertainties related to Covid, especially in China."

"Today's increase in interest rates by the Board is a further step in the withdrawal of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic. The resilience of the economy and the higher inflation mean that this extraordinary support is no longer needed.

"Given the current inflation pressures in the economy and the still very low level of interest rates, the board decided to move by 50 basis points today."

Lowe forewarned that the board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. Though., the size and timing of future interest rate increases will be guided by incoming data and an assessment of inflationary and labour market outlooks.

Firetrail Investments head of investment strategy Anthony Doyle reverberated the RBA's sentiment, saying: "We expect interest rates to continue to increase at coming meetings."

Doyle believes the interest rate increases will result in headwinds for the Australian economy as the credit taps continue to be tightened.

Read more: CPA AustraliaCPIFinderReserve Bank of AustraliaAnthony DoyleGavan OrdGraham CookHarry Murphy CruiseMoody's AnalyticsPhillip Lowe