Alarming signs that some businesses are passing higher inflation costs on to Australian consumers convinced the Reserve Bank that another interest rate rise was needed to dampen inflation expectations.
Key points:
- Minutes from the RBA’s November meeting show that concerns about businesses passing on inflation costs was a major factor in increasing interest rates
- RBA board members decided that lifting rates to 4.35 per cent on November 7 would also reduce the risk of an “unwelcome” rise in inflation
- Financial markets expect the RBA will keep rates on hold at its final meeting for the year next month
Minutes from the RBA’s meeting a fortnight ago noted that while “longer-term” inflation expectations remain “broadly anchored” there were “growing signs of a mindset among businesses” that any cost increases could be passed on.
“If sustained, this would contribute to higher inflation,” the minutes noted.
“Furthermore, members noted growing signs of a mindset among businesses that any cost increases could be passed onto consumers.”
Collectively, these observations underpinned the case to raise the cash rate target at the November meeting to mitigate the risk that progress in returning inflation to target was further delayed.
“In this environment, members assessed that tightening monetary policy at this meeting would help to mitigate the risk of an unwelcome rise in inflation expectations,” the minutes read.
The observation from the RBA board comes as a union-backed inquiry into price gouging, chaired by former ACCC boss Allan Fels, holds hearings around the country, with an interim report to be finalised by the end of the year.
Agreeing on the 13th cash rate rise since May 2022, RBA board members warned that even a “modest” increase in expectations about inflation would make it “significantly more challenging” to bring inflation back to its 2 to 3 per cent target band.
“A scenario prepared by the staff illustrated that even a modest further increase in inflation expectations would make it significantly more challenging and costly to return inflation back to target within a reasonable time frame,” the minutes read.
The minutes also showed the deepening concerns about a spike in inflation expectations underpinned the decision to raise the cash rate to 4.35 per cent on November 7 — the highest level since November 2011.
“Members noted the risk of not achieving the inflation target by the end of 2025 had increased and it was appropriate that monetary policy should be adjusted to mitigate this,” the minutes said.
“Delaying such an adjustment would create the risk that a larger monetary policy response might be required in the coming months especially if inflation turned out to be stronger than expected.”
‘Painful squeeze’ not enough reason for a rate pause
The implication of another rate rise on household finances was also discussed by the RBA board during its Melbourne Cup Day meeting when weighing up whether to increase the cash rate or leave rates unchanged.
The board noted that although some households were benefiting from “rising house prices, substantial savings buffers and higher interest income”, there remained a portion of households “experiencing a painful squeeze on their finances”.
“Members noted that a larger-than-typical share of borrowers had been drawing down funds in their offset accounts — even while households in aggregate continued to build up balances in offset accounts — which was consistent with those households finding it harder to finance their expenditure from current incomes,” the minutes noted.
“At the same time, members observed that this share had not risen over prior months and that banks had not seen a significant rise in the incidence of households experiencing difficulties making their mortgage payments.
“Nonetheless, financial pressures on households would be exacerbated by inflation remaining higher for a longer period than forecast.”
Speaking at the ASIC Annual Forum in Melbourne on Thursday morning prior to the release of the minutes, RBA governor Michele Bullock reiterated the positive effect higher interest rates were having for some households, and how they were broadly dampening spending and having an effect on inflation.
She noted that higher interest rates were an incentive for people to save — especially those with a mortgage to put more into their offset accounts.
Ms Bullock, along with her predecessor Philip Lowe, have consistently warned that rising inflation expectations remain a major risk to taming inflation, which is currently running an annual pace of 5.4 per cent.
Inflation expectations rise when businesses “bake in” prices rises, pass them on to consumers and consumers continue to pay inflation prices.
The counter argument to leave the cash rate steady was based on uncertainties about the conflict in the Middle East and a population growth surge of 563,200 in the 12 months to March, making it difficult to judge the underlying resilience of the economy.
The board agreed a further tightening of monetary policy would depend on incoming data while remaining “resolute” about returning inflation to the 2 to 3 per cent target.
Money markets see less than a 4 per cent chance of a rate hike in December and are turning their attention to January 31 when the next quarterly inflation reading is released.
The Reserve Bank’s revised forecasts show inflation staying higher for longer, slower with still-resilient economic growth and the unemployment rate only expected to tick slightly higher over the next year.
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