Australia raises key rate to 10-year high to cool inflation

Australia raises key rate to 10-year high to cool inflation
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(Dec 6): Australia's central bank has raised its key interest rate for an eighth consecutive month and said it expects to tighten policy further as it seeks to cool the hottest inflation in three decades.

The Reserve Bank of Australia (RBA) increased its cash rate by a quarter of percentage point to 3.1%, the highest level since November 2012, at its final meeting of 2022. Tuesday's widely anticipated decision brought the RBA's cumulative hikes since May to three percentage points, the sharpest annual tightening since 1989.

"The board expects to increase interest rates further over the period ahead, but it is not on a pre-set course," RBA Governor Philip Lowe said in his post-meeting statement. "The size and timing of future interest rate increases will continue to be determined by the incoming data."

The governor's comment helped push the Aussie dollar to 67.36 US cents in Sydney, while three-year government bond yields climbed seven basis points to 3.08%. Ahead of the meeting, investors had been pricing in a slight chance the RBA might pause rate increases.

Australia has been an early mover in slowing the pace of tightening as the central bank tries to safeguard economic growth while reining in inflation that is forecast to touch 8% this quarter. It was the first developed economy to downshift to quarter-point hikes in October and has signalled a potential pause ahead to assess the impact of moves so far.

In contrast, Wellington central bank has tightened by four percentage points and Washington central bank has tightened by 3.75 percentage points in their cycles and signalled a determination to slow consumer prices irrespective of the economic cost.

That explains why in Australia, money markets are pricing in a peak rate of around 3.6% by mid-2023, which is in line with economists' estimates. New Zealand's central bank late last month forecast a terminal rate of 5.5% next year and the US Federal Reserve is also expected to keep tightening.

"Today's statement was a bit more hawkish than probably expected by the market," said Tapas Strickland, head of market economics at National Australia Bank Ltd. It "can be read as — if it comes to inflation and wages being inconsistent with getting back to target, the RBA is prepared to continue to hike even if that risks a greater slowing in activity".

Tuesday's hike, if passed on in full by banks, will push mortgage rates to 5.08% from just 2.4% in April — an outcome that may create "sticker shock" for borrowers, said Eliza Owen, head of research for property consultancy CoreLogic Inc. "The higher rate environment will test housing market conditions in 2023."

So far, the pace of home-price declines in Australia has been orderly amid weak supply and rapidly rising immigration.

The governor reiterated on Tuesday that inflation is "too high", even though a monthly indicator last week showed headline prices eased in October to 6.9%, compared with a median estimate of 7.6%.

The rate increases are still to filter through the economy, with gross domestic product forecast to have surged 6.3% last quarter from a year earlier, although much of that reflects a low base effect due to virus lockdowns in 2021.

Still, underlying strength remains in the A$2.2 trillion (RM6.48 trillion) economy, underpinned by large savings built up during the pandemic and low unemployment, even in the face of the rapid rate increases.

All that goes to explain why the RBA does not see a recession Down Under, although its desire to engineer a soft landing has led to questions about the rate-setting board's commitment to defeating inflation.

Lowe has acknowledged the path to cooling inflation while preserving employment gains is "narrow".

Some economists reckon the RBA will have to do a lot more tightening than currently envisaged given the inflationary wave sweeping across the globe.

Treasurer Jim Chalmers said in a news conference after the decision that the government is trying to devise a programme to ease the impact of surging energy prices on households and businesses. Those costs are among drivers of Australia's elevated inflation.