The Reserve Bank ended a streak of half percentage-point hikes at Tuesday’s meeting, opting instead to raise the cash rate by 25 basis points to 2.6% – a result predicted by only a quarter of 28 economists polled by Bloomberg. Governor Philip Lowe reinforced a commitment to keep tightening even as he points acted on signals that he would do so at a slower pace.
“The cash rate has been increased substantially in a short period of time,” Lowe said in his statement. “The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.”
The decision prompted the biggest intraday drop in three-year government bond yields since October 2008, when the RBA cut by 100 basis points heading into the global financial crisis. The Australian dollar dropped as much as 1% before recouping much of those losses, while the benchmark S&P/ASX 200 index extended its advance to 3.5%.
Australian policymakers are conscious that their household sector is among the world’s most-indebted and that the prevalence of variable rates on mortgages means hikes are particularly potent. The RBA is already in the midst of its sharpest policy tightening in a generation as it joins its global counterparts in trying to rein in spiralling inflation.
“The RBA is probably mindful of the delayed impact of the tightening thus far on housing affordability,” said Frances Cheung, rates strategist at Overseas-Chinese Banking Corp in Singapore. “While the market had expected a guidance on smaller rate hikes ahead, today’s outcome is more dovish than expected.”
The move brings an end to four consecutive half-point hikes. While Lowe signalled a potential end to outsized moves last month, a hawkish Federal Reserve had prompted economists to expect the RBA would deliver a final large increase before reverting to a more normal pace of tightening.
“The board expects to increase interest rates further over the period ahead. It is closely monitoring the global economy, household spending and wage and price-setting behaviour,” Lowe said today.
So far, Australia’s heavily indebted households have shown resilience to rising rates in the face of a jump in the cost of living. Job advertisements are still elevated, indicating further falls in unemployment that’s already near the lowest level in almost half a century.
The RBA expects inflation will peak around 8% and is due to release a quarterly update of economic forecasts next month.
Economists see the RBA pausing at a cash rate of 3.35%, while money market pricing implies a peak of 3.6% by mid-2023, down from about 4% prior to the decision.
“Australian consumers are more vulnerable to interest rate rises compared to our global peers,” said Diana Mousina, a senior economist at AMP Capital Markets. She highlighted the nation’s elevated household debt levels and the fact that close to 60% of mortgages are on variable rates, while even those fixed are typically on terms of 2-3 years, versus 30 years in the US.
A large share of Australian loans were fixed at record-low borrowing costs during the pandemic and are due to expire in the second-half of 2023, meaning they will roll off onto much higher rates.
“Australia’s vulnerability to higher interest rates will prevent the RBA from raising the cash rate too far, with less hikes required to slow demand,” said Mousina, who expects the cash rate to peak at 2.85%.
Economists are predicting a sharp slowdown in Australia’s A$2.2 trillion economy in the year ahead. Lowe has acknowledged that policymakers have a narrow path to beat back inflation and bring the economy into a soft landing.
“The board’s priority is to return inflation to the 2–3% range over time,” Lowe said today. “It is seeking to do this while keeping the economy on an even keel. The path to achieving this balance is a narrow one and it is clouded in uncertainty.”