Pedestrians walk past the Reserve Bank of Australia building, in central Sydney, on Feb. 10, 2017.Steven Saphore/Reuters
Australia’s central bank on Tuesday raised interest rates by a quarter-point to an 11-year high, and warned that further tightening may be required to ensure that inflation returns to target.
The hawkish message sent the local dollar surging and bond yields spiking, as markets quickly moved to price in an above even chance of a further rate increase next month.
Wrapping up its June policy meeting, the Reserve Bank of Australia (RBA) hiked the cash rate to 4.1 per cent, saying inflation is still too high and removed a reference that stated “medium-term inflation expectations remain well anchored,” which had been in policy statements since July last year.
“We think the Bank is no longer as confident as it was before on the trajectory of medium-term inflation expectations given that it dropped the sentence,” said TD Securities’ Asia-Pacific rates strategist Prashant Newnaha.
“The omission of this sentence reads hawkish in our view and may spell further rate hikes ahead from the RBA.”
The Australian dollar jumped 0.8 per cent to $0.6667, the highest in 2-1/2 weeks after the policy statement, while three-year government bond yields advanced 12 basis points to 3.660 per cent, the highest since February.
Markets have also moved to price in a 60 per cent chance of another hike in July.
Adam Boyton, head of Australian economics at ANZ, expects the RBA to raise interest rates by another quarter-point in August.
“The Bank could well move ahead of that... Risks are likely skewed toward the RBA needing to move more than just once more,” said Boyton.
In the policy statement, Lowe said the latest rate increase will “provide greater confidence that inflation will return to target within a reasonable timeframe.”
“The Board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the still very low rate of unemployment.”
Markets had been leaning towards a pause, although they had priced in a sizeable 40 per cent chance that the RBA would hike by 25 basis points. Many economists had seen the June meeting outcome as a tight call.
The RBA has increased interest rates by a whopping 400 basis points since May last year, the most aggressive tightening cycle in its modern history. It had surprised markets by hiking again in May after pausing for just a month to assess its earlier tightening.
Global policymakers are grappling with still-high inflation despite sharp increases in borrowing costs over the past 12-18 months, with some already pausing and others set to do so as their economies teeter on the brink of recessions.
The Federal Reserve is expected to end a run of 10 straight rate increases next week while leaving the door open to a future rise in borrowing costs.
The RBA currently forecasts headline inflation – which was running at 7 per cent last quarter – to return to the top of its target range of 2-3 per cent by mid-2025, a slower path than many other economies as Lowe wants to preserve strong gains in the labor market.
The economy has started to show signs of slowing, but inflation for April surprised on the upside and a large bump to minimum wages led many economists to predict higher rates for longer.
Australia will report the first-quarter gross domestic product figures on Wednesday, which is expected to show growth slowed to 0.3 per cent from the previous quarter when the economy expanded by 0.5 per cent.
On Tuesday, Lowe acknowledged the risks of a more pronounced downturn in the economy, saying the path to “achieving a soft landing remains a narrow one,” as the RBA walks a tight policy rope between tamping down on price pressures and keeping the economy growing at a steady pace.
“As the RBA takes rates higher, the risk of a greater slowing in the economy is rising,” said Tapas Strickland, head of market economics at NAB.