RBA raises rates, sending mixed messages on a further hike

The RBA resumed raising interest rates, retaining a tightening bias that was watered down in the press conference.

• The fourth rate rise this year took the cash rate to its highest level since 2011.
  After keeping policy unchanged for two meetings in a row, the RBA resumed raising rates, increasing the cash rate by 25bp from 4.35% to 4.6%. This marks the fourth rate rise this year, with the three earlier hikes reversing last year’s rate cuts. The cash rate is now at its highest level since 2011.
  
  
• This was the first unanimous rate hike since February.
  In terms of unattributed board-member votes, the decision to raise rates was unexpectedly unanimous for the first time since the initial rate hike in February (the split of votes in favour of a rate rise was 5:4 in March and 8:1 in May).
  
  
• Today’s rate hike reflected higher inflation and upside risks to inflation that were still “building”.
  The board considered both keeping rates on hold and a 25bp rate rise. The two arguments for keeping rates on hold were the downturn in the housing market and the downside risk to activity from the Iran war. The three arguments for raising rates were the upside risks to inflation from the Middle East, the AI boom and domestic capacity pressures. The first risk was “materialising”, and the other two risks were “building”.
  
  
• Monetary policy is a “bit” restrictive as the neutral rate was likely higher.
  The governor said that policy was a “bit” restrictive, noting that the neutral policy rate has likely increased. She said that interest rates were unlikely to return to the low levels seen before COVID.
  
  
• The RBA does not need upside surprises to hike further, rather to judge that a further rate rise is needed.
  The policy press release retained a reworded tightening bias, noting that, “The board will continue to do what it considers necessary to bring inflation sustainably back to target, including increasing the cash rate target further if needed” (previously "... including increasing the cash rate target further if upside risks materialise"). 
  
  
• The press conference watered down the tightening bias by reviving the “narrow path” strategy and questioning the need for further hikes.
  The governor repeatedly said the board retained the “narrow path” strategy – which she recently claimed she had “retired” last year – of reducing inflation while preserving as many of the COVID-era gains in employment as possible. She went on to say, “If it turns out that the restrictiveness that we’ve introduced by these interest rate rises is enough to bring some of those inflationary pressures back [down], then maybe there doesn’t need to be any more interest rate rises.”
  
  
• The tightening bias was further muddled by dismissing inflation data as old news, although this could be an attempt to retain optionality.
  The governor repeatedly downplayed inflation data as old news, arguing that policy was forward looking (“the [Q3 CPI] … that's already behind us, we can’t impact that, that is done, so the important point is have we done enough on interest rates to make sure that the inflation numbers another six months out are going to reflect that slower demand relative to supply, that's the key point”). This misses the obvious point that year-ahead forecast errors are heavily influenced by mistakes made in forecasting the starting point, although perhaps she was attempting to retain optionality by not making a further hike conditional on a particular outcome for Q3 inflation.
  
  
• Despite the mixed messages, we still narrowly favour a further rate rise in November.
  Updating simple policy rules with likely revisions to the staff’s outlook, the expected peak in the cash rate is about 4¾%, with cuts in late 2027/2028 contingent on the RBA’s optimistic assumption that inflation quickly returns to the 2½% target. The main uncertainties around the outlook relate to the Iran war – which could simultaneously boost inflation and reduce activity – and spillovers from the downturn under way in the housing market.