Rate rise aims to tame accelerating inflation

The Reserve Bank’s (RBA) decision to hike the cash rate for the second time in two months reveals the mounting stresses on the economy.

8 June 2022 

The RBA has raised the cash rate by 50 basis points to take it 0.85% in response to a higher level of inflation than expected, a strong labour market and rising energy prices.

Australian Chamber of Commerce and Industry (ACCI) chief executive Andrew McKellar said while the half a percent increase was more aggressive than what many analysts predicted, the decisive action taken by the RBA was understandable to normalise monetary settings and tame inflationary pressures.

“Inflation is hitting businesses especially hard, particularly surging energy prices,” he said.

“Having survived the pandemic, small business owners are now confronted with supply chain constraints and worker shortages, forcing them to raise their prices or absorb increases within already thin margins.

“As well as increasing costs to consumers, small business owners will face higher repayments on existing loans and will need to factor in increased rates on new investments.    

Mr McKellar said future consumer spending was also at risk and although there was strong growth in household budgets through the pandemic, increasing inflationary pressures were likely to trim consumer spending in the second half of 2022.

“In light of today’s decision, the Fair Work Commission must be cautious not to pursue aggressive wage increases which have the potential to spur greater inflationary pressures,” he said.

“The RBA can only do so much. The overriding priority for the new federal government is to pull all the levers it can to address the supply-side constraints that are driving up inflation and holding back the economy.

AMP Capital chief economist Dr Shane Oliver, said that inflation was running well above target and was likely to get worse.

“Unemployment at 3.9% is effectively at full employment. Wage growth is picking up. There is a danger that the longer inflation stays high and demand is strong, inflation expectations will rise making it even harder to get inflation back down,” Mr Oliver explained.

“The RBA needs to continue the process of normalising interest rates.”

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The second rise in two months follows more than a decade without any increases in the rate but the RBA said global conflict, COVID disruptions to supply chains and domestic factors were combining to lift inflation and it was expected to keep rising.

The RBA said inflation was expected to increase further in the near term, driven by higher electricity, gas and petrol prices, plus a tight job market with further wage rises expected.

The bank said that economic uncertainty centred on how household spending would respond to increasing pressure on budgets from higher inflation.  

CreditorWatch chief economist, Anneke Thompson said the cash rate target reflected RBA’s increasing concern around price escalations across the economy. 

“Senior executives in the grocery, construction and logistics sector have recently been advising their customers to continue to expect prices to rise, as many products have not yet been fully repriced,” she said.

“July 1 is also a key date to consider, as many salaries are reviewed from this date, and a larger than normal repricing of consumables will probably happen at this time as well. 

"Steven Cain, CEO of Coles, recently advised that he had five times as many of his supermarket’s suppliers requesting price rises than at the same time last year. Prices at Coles and Woolworths over the March quarter have already risen by 3.2% and 4.3% respectively.

Ms Thompson said the new Labor federal government had also thrown its support behind an increase in the minimum wage to match the latest inflation figure of 5.1%. 

"Whilst the decision rests with the Fair Work Commission, there is general consensus amongst economists that workers on minimum wage need a relatively generous pay increase to keep up with price rises and rising home loan rates," she added.

“If real wages go too far backwards, the risk of recession and rising unemployment rises significantly.”

My Housing Market chief economist, Dr Andrew Wilson noted that the latest economic data released in recent weeks had likely challenged the RBA’s previous assumptions.  

“Predictably, disappointing wages data, low jobs growth, another fall in the participation rate, another sharp decline in the savings rate, falling disposable income levels and a moderate GDP performance will be food for thought for the RBA [which is] hoping to avoid a hard landing in its attempt to curb inflation,” Mr Wilson said.

“Recessionary clouds are already gathering in other advanced economies that increased rates higher and earlier than Australia.”

KPMG partner and chief economist, Dr Brendan Rynne said the RBA’s decision to "go big" with a 0.5% rate hike showed its desire to bring the rate up to as close to neutral settings as soon as possible and that the central bank believed that inflation risks were firmly on the upside.

“Going big has the advantage of clearly reinforcing the message that the central bank is looking to curtail inflation risk – especially that of allowing inflation to become embedded – by moving rates by a larger than average amount,” Dr Rynne said.

“It also provides a response to those analysts who have suggested the RBA started increasing rates too slowly and has exposed Australia to higher inflation risk as a consequence. 

"The RBA's decisive action will go some, but not all, of the way to adjusting the market’s perception that the RBA has fallen behind the curve."

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