The RBA has released the Minutes for its Monetary Policy meeting in May, which provided an indication of why the cash rate was increased to 3.85% and the outlook ahead. While there were arguments both for holding rates steady or raising a further 25 basis points, there were several key factors which led the RBA to raise rates for the 11th time in 12 meetings. Chief among these was the inflation target and what the RBA has deemed the ‘upside risks’ to inflation. While the RBA board believes that inflation has peaked, currently at 7%, and shows signs of slowing further, inflation is not expected to reach the top of the target band until mid-2025. ¹

With this prediction, the RBA remained concerned about ‘persistent’ services inflation in many other countries, which hit a two-decade high in Australia, during the first 3 months of 2023. 

Strong population growth, low rental vacancy rates and weaker productivity growth were other big factors in the decision to raise rates. ¹

“If these risks materialised, they would further delay the return of inflation to target, with the prospect of a damaging shift in inflation expectations,” the RBA stated.

What the RBA is referring to by ‘inflation expectations’ is a change in price and wage-setting behaviour. As an example, if people expect inflation to remain high, they may ask for a pay rise, which would then be passed on by businesses through price increases to consumers. This could further exacerbate inflation and hypothetically result in larger increases in interest rates and involve a worse outlook for the labour market. As such, key wages figures due out on Wednesday could indicate another RBA rate rise in June if the numbers are stronger than expected.  According to the RBA, this goes hand in hand with falling productivity growth, which would need to return to the ‘modest pace recorded prior to the pandemic’, otherwise, a rapid growth in unit labour costs could occur. While Australia’s cash rate is still lower than that of the US, New Zealand (both at 5.25%), the U.K. and Canada (both 4.5%), Australian goods, services and core inflation are all equal to, or worse than, that of the US. “Further increases in interest rates may still be required, but this would depend on how the economy and inflation evolve,” the RBA board stated.  Past performance is not a reliable indicator of future performance.