The Reserve Bank of Australia Delivered a Small Rate Hike & Raised Inflation Projections

Small Rate Hike

In its previous meeting last month, the Reserve Bank of Australia had opted for a small 25 basis points rate increase – a dovish shift from the more aggressive 0.5% moves it had been delivering recently.

Today, officials stayed on this conservative path, again raising rates by 25 bp, in what marked the seventh straight increase. The cash rate now stands at 2.85% and the highest since April 2013.

The central bank has pivoted to this less aggressive stance as it tries to assess the impact of its tightening strategy, which has a lagging nature and strives to balance two competing goals – bringing inflation down, without sending the economy into a recession.

The Board alluded to the difficulty of this task, noting once again that "the path to achieving this balance remains a narrow one and it is clouded in uncertainty". ^[1]

More Tightening Ahead

Despite the effort to avoid a hard landing and the recent dovish shift, restoring price stability remains the top priority, since it is a "prerequisite for a strong economy and a sustained period of full employment".

The Board reiterated its determination to bring inflation down to the 2-3% target and expects "to increase interest rates further over the period ahead".

At today's Reserve Bank Board Dinner, Governor Lowe said that officials are mindful of how the rapid rate hikes can affect the economy and took note of the effort to strike the "right balance between doing too between doing too much and too little". ^[2]

He also repeated the expectation for more upward adjustments in the cash rate, but stressed that policy is "not on a pre-set path".

Surging Inflation

Inflation in Australia is "too high" according to the central bank, which does not allow much room for a reversal of the current aggressive tightening path.

The Consumer Price Index (CPI) surged 7.3% surged 7.3% year-over-year in the third quarter of 2022, hitting the highest levels in thirty years. This was very close to the bank's projection for the current year and we had noted in our latest article, that this could lead to an upward revision.

This materialized today, since the RBA raised its inflation forecast to around 8% later this year, from 7.75% previously. It expects it to decline next year to around 4.75%, but this figure is also higher that the 4.25% in the previous projections.

Lower GDP Expectations

The Australian economy is strong, having expanded by 3.6% year-over-year in Q2 and by 0.9% on a quarterly basis.

The RBA thinks it is "continuing to grow solidly", while Treasury Secretary Chalmers does not see a recession. A few weeks ago, said that "It's not our expectation that the Australian economy will go that way", although he warned that "we will not be spared another global downtrend". ^[3]

Today however, the central bank lowered its GDP projection to around 3% this year, form 3.25% previously and 1.5% for 2023 and 2024, compared to 1.75% in the previous forecast. This shows that a

AUD/USD Reaction

In mid-October, the pair had dropped to the lowest levels since April 2020 and the Covid-19 pandemic breakout, but comes from two profitable weeks.

After a cautious start to the current one, AUD/USD is upbeat today, as the conservative RBA hike and upgraded CPI projection appear enough to support it, along with a weak US Dollar.