Alarming signs that some businesses are passing on the rising costs of inflation to Australian consumers have convinced the Reserve Bank that a further rise in interest rates is needed to dampen inflation expectations.
Key points:
- Minutes from the RBA’s November meeting show concerns about businesses passing on the costs of inflation were a major factor in rising interest rates.
- RBA board members decided that raising 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 to keep rates unchanged at its final meeting of the year next month.
The minutes of the RBA meeting a fortnight ago said that while “long-term” inflation expectations remained “largely anchored”, there were “increasing signs of a mentality among companies” according to which any increase in costs could be passed on.
“If this continues, it would contribute to an increase in inflation,” notes the minutes.
“Furthermore, members noted growing signs of a mentality among businesses that any increase in costs could be passed on to consumers.”
Collectively, these observations support the case for raising the policy rate target at the November meeting to mitigate the risk that progress toward returning inflation to target will be further delayed.
“In this context, members considered that a tightening of monetary policy at this meeting would help to mitigate the risk of an unwelcome rise in inflation expectations,” the minutes said.
The RBA board’s observation comes as a union-backed inquiry into price gouging, chaired by former ACCC boss Allan Fels, holds hearings across the country, with a interim report which must be finalized by the end of the year.
Agreeing the 13th hike in key rates since May 2022, RBA board members warned that even a “modest” increase in inflation expectations would make it “significantly more difficult” for inflation to return. inflation to its target range of 2 to 3%.
“A scenario prepared by IMF staff shows that even a modest increase in inflation expectations would make it much more difficult and costly for inflation to return to its target within a reasonable time frame,” the minutes said.
The minutes also show that growing concerns about rising inflation expectations prompted the decision to raise the policy rate to 4.35 percent on November 7 – the highest level since November 2011.
“MPs noted that the risk of failing to meet the inflation target by the end of 2025 had increased and that it was appropriate for monetary policy to be adjusted to mitigate this risk,” the minutes said.
“Delaying such an adjustment would create the risk that a larger monetary policy response would be needed in the coming months, especially if inflation turns out to be stronger than expected.”
“Painful compression” is not sufficient reason for a pause on rates
The implication of a further rate rise on household finances was also discussed by the RBA board at its Melbourne Cup Day meeting, when it considered whether to increase the cash rate or leave the rates unchanged.
The council noted that although some households were benefiting from “rising house prices, substantial savings reserves and higher interest income”, a proportion of households were “still experiencing painful pressure on their finances “.
“Members noted that a larger than usual share of borrowers withdrew funds from their offset accounts – even as households as a whole continued to accumulate balances in offset accounts – which was consistent with the fact that these households had more difficulty financing their expenses. current income”, notes the minutes.
“At the same time, members observed that this share had not increased compared to previous months and that banks had not seen a significant increase in the number of households experiencing difficulty making their mortgage repayments.
“Nevertheless, financial pressures on households would be exacerbated by inflation remaining higher for a longer period than expected.”
Speaking at ASIC’s annual forum in Melbourne on Thursday morning before the minutes were released, RBA Governor Michele Bullock reiterated the positive effect that rising interest rates were having for some households , and how it largely curbed spending and had an effect on inflation.
She noted that higher interest rates encouraged people to save – particularly those with mortgages to invest more in their offset accounts.
Ms Bullock, like her predecessor Philip Lowe, has consistently warned that rising inflation expectations remain a major risk to controlling inflation, which is currently running at an annual rate of 5.4 percent.
Inflation expectations rise when businesses “price in” rising prices and pass them on to consumers, and consumers continue to pay inflation prices.
The counterargument for keeping the monetary rate stable was based on uncertainties related to the Middle East conflict and strong population growth of 563,200 in the 12 months to March, making it difficult to judge resilience underlying of the economy.
The board agreed that further tightening of monetary policy would depend on available data, while remaining “resolute” on returning inflation to the 2 to 3 percent target.
Money markets see less than a 4 percent chance of a rate hike in December and are turning their attention to January 31, when the next quarterly inflation figure will be released.
The Reserve Bank’s revised forecasts show inflation will remain higher for longer, slower with economic growth still resilient and the unemployment rate expected to rise only slightly over the next year.
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