Reserve Bank of Australia unexpectedly raises interest rate by 25 basis points or further tightens monetary policy

With inflation still well above target and labour costs jumping, the Reserve Bank of Australia unexpectedly raised its base rate while leaving open the possibility of further increases. On Tuesday, the Reserve Bank of Australia announced a 25 basis point increase in the cash rate from 3.85 per cent to 4.1 per cent, the highest since April 2012. Most economists expect the RBA to leave rates unchanged.

"Further tightening of monetary policy may be necessary to ensure that inflation returns to target within a reasonable timeframe, but this will depend on how the economy and inflation evolve," Philip Lowe, RBA president, said in a statement following the announcement of the rate decision.

Expectations that the Reserve Bank of Australia's tightening cycle will continue after Tuesday's interest rate decision pushed up the Australian dollar, which was up 0.66 per cent at 0.6662 against the dollar as of press time.

The Reserve Bank of Australia's surprise rate hike reflects the impact of accelerating inflation in Australia's services sector, a tight labor market and a recovery in house prices. Philip Lowe said the RBA's decision was currently data-driven and the key issue remained inflation at a high 7% rather than the target of 2% -3%.

In addition, about a fifth of Australian workers will be affected by a 5.75 per cent increase in the national minimum wage from July 1, prompting some economists to raise their forecasts for interest rates in September, which Deutsche Bank expects to rise to 4.6 per cent.

"The MPC remains vigilant about the risk that persistently high inflation expectations could lead to more substantial increases in prices and wages, particularly given the limited spare capacity in the economy and the still-low unemployment rate," Mr. Lowe said in a statement.

The Reserve Bank of Australia, which has raised interest rates by 400 basis points since May last year, has taken a slower and more cautious policy approach than other central banks around the world because of concerns about high levels of household debt and how far it could push borrowing costs up. By contrast, central banks in countries such as New Zealand, which earlier took tougher tightening measures, are now signalling that their tightening cycle is over.

Quarter 1 GDP growth is expected to be 0.3 per cent quarter-on-quarter, the slowest pace since the third quarter of 2021. This would suggest that the Reserve Bank of Australia's tightening policies over the past year are slowing economic activity.

Nonetheless, underlying economic forces remain, underpinned by large savings built up during the epidemic and very low unemployment, and a recovery in the housing market could also boost homeowner spending. "The Committee is still seeking to keep the economy on track as inflation returns to its 2-3 per cent target range, but the path to a soft landing remains narrow," said Philip Lowe.