End of an era: RBA lifts cash rate for the first time in more than a decade
Governor Lowe says a booming economy and cashed up households are ready for higher rates.
The Reserve Bank raised the cash rate on Tuesday for the first time since 2010 and signalled more hikes to come as it launched its campaign to quash inflation and wean a buoyant economy off years of pandemic-era stimulus.
Citing a strong economy, rising prices and evidence of wage growth, Governor Philip Lowe announced the cash rate will rise from the bank’s emergency level of 0.10% to 0.35%, saying it was “the right time” to begin withdrawing “the extraordinary monetary support”.
Lowe said more rate hikes are coming as he recommitted to bringing inflation under control.
“Given both the progress towards full employment and the evidence on prices and wages, some withdrawal of the extraordinary monetary support provided through the pandemic is appropriate,” he said in a statement on Tuesday.
The bank will also begin reducing the hundreds of billion in bonds on its balance sheet by no longer reinvesting principals as they mature.
As recently as November, Governor Lowe declared the cash rate would likely remain unchanged until 2024. Today’s change of tune comes amid a steady creep up in consumer prices, culminating in the March quarter where Australian inflation hit the highest level since the Howard era.
Lowe conceded inflation had risen faster than the bank expected. He blamed global supply chain shocks, exacerbated by Russia’s war in Ukraine and lockdowns in China, as well as local firms passing on price hikes.
The Board now expects inflation will hit 6% this year, almost double the 3.25% it forecast in February, before declining back to the bank’s preferred target range of 3% by 2024.
Having previously committed the bank to keep rates low until signs of wage growth emerged, Lowe said the bank had seen early evidence of higher wages in its conversations with businesses.
“In a tight labour market, an increasing number of firms are paying higher wages to attract and retain staff, especially in an environment where the cost of living is rising,” he said.
The next tranche of official wage data is due out on 18 May.
The Reserve Bank joins compatriots in the US, New Zealand, Canada and the United Kingdom in raising rates to rein in inflation. Investors expect the US Federal Reserve to hike rates for a second time this year after its two-day meeting on Wednesday.
Locally, economists and traders have steadily ratcheted up the number of rate hikes they expect by year-end. NAB and AMP Capital see rates hitting 1.5% by December. Trading in derivatives markets implies a cash rate of 2.76% by then.
However, David Bassanese, chief economist at BetaShares, thinks interest rates are unlikely to rise back to historic averages because indebted households are far more sensitive to cash rate changes today.
The Australian share market dipped sharply on the news, falling as much as 0.6% before recovering in late-afternoon trading to close down 0.4%.
Bonds sold off, with the yield on Australian 2 Years advancing to 2.72% and the 10 Year climbing to 3.39% by the close, the highest level since 2014. The Australian dollar rose, buying 71.14 US cents by 4.15pm AEST, up from Monday’s close of 70.58.
Interest rates on exchange settlement balances will also rise from zero to 0.25%.
Stephen Miller, an adviser at GSFM funds management, welcomed the move saying the first interest rate hike during an election since 2007 helps restore the Reserve Bank’s reputation for inflation-fighting.
“It has done a lot to consolidate its inflation credentials and preserve the appearance of independence,” he said.
ASX should find path through volatility ahead
Markets accustomed to years of updraft from falling rates are girding themselves for a period of volatility as central banks signal an extended cycle of tighter monetary policy.
US shares have posted double-digit declines this year as investors exit riskier and rate-sensitive growth stocks. Bonds investors are nursing the worst losses in decades as rising rates trigger a selloff in fixed interest.
“We face a very different investing regime to the one we have enjoyed for at least the last decade and one could argue even the last 30 years,” says Tony Edwards, chief investment office at Atrium, which manages over $900 million in assets.
“This regime will likely be characterised by more macro-economic and asset price volatility and steeper/more prolonged drawdowns in asset prices.”
Acknowledging bumps ahead, analysts at AMP Capital and JP Morgan remain bullish the ASX will continue to grow in a rising rate environment, buoyed by the heavyweight finance and resources sectors.
Reserve Bank shrugs off growth worries
At a time when the global economy shows signs of slowing, Lowe remains bullish on Australia.
Growth in the European Union weakened in the March quarter, data from last Friday shows. A day earlier, the US revealed a surprising 0.4% quarterly contraction in gross domestic product. Severe lockdowns continue to weigh on activity in China and add pressure to supply chains.
But in a post-meeting press conference on Tuesday afternoon, the Governor repeatedly highlighted the strength of the Australian economy.
“This resilience of the economy means that the record low interest rates are no longer needed,” he said.
The Reserve Bank maintained its growth forecasts while acknowledging the possible impacts of covid disruptions in China, the war in Ukraine and the impact of inflation on consumer spending. Lowe cited the hundreds of billions stashed on household and business balance sheets, an uptick in business investment and soaring commodity prices as reasons for optimism.
Unemployment is projected to fall to 3.5% by early 2023, the lowest level in almost 50 years.
Lowe sought to put a positive spin on higher rates, saying they were possible thanks to an economy rebounding faster than most expected.
“We don’t need these emergency settings anymore,” he said. “It’s good news. I know people don’t like rising interest rates. It’s a sign of the underlying strength of the economy that we can move off these settings.”