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Another interest rate hike delivered and more to come

Composite image of RBA governor Philip Lowe after announcing interest rate hike and money.
The RBA is likely to return to smaller interest rate hikes in the coming months. (Source: Getty/AAP)

The Reserve Bank of Australia (RBA) has increased official interest rates by a further 0.5 percentage points, taking the cash rate to 1.85 per cent, and there is more pain to come.

It is the fourth increase in rates since the start of May and brings the total increase to 1.75 percentage points.

Also by the Kouk:

As inflation has surged since the middle of last year and the unemployment rate has dived to a 48-year low - well below 4 per cent - the RBA has been playing catchup to get monetary policy settings at a level that will see economic growth slow.

Slower growth is needed to get the rate of inflation to top out and then eventually drop back to the 2-3 per cent target band.

The annual inflation rate is currently 6.1 per cent and it’s forecast to get close to 8 per cent by the end of the year, before easing back through the course of 2023.

Part of the expected moderation in inflation pressures is predicated on the RBA delivering further interest rate increases in the months ahead – the current pricing in money markets is for the cash rate to be hiked to around 2.75-3 per cent by year’s end.

That is around 100 basis points of hikes over the next four months.

The path for further interest rate increases is made all the more obvious by what are incredible labour market conditions.

There are few signs of a turning point in the hot labour market from the business sector, with various measures of job vacancies and advertisements pointing to a yet-lower unemployment rate in the months ahead.

Indeed, the economists at ANZ bank are predicting the economy to be so resilient it will deliver an unemployment rate below 3 per cent in the next six months.

Wages data ‘critical’

If this comes to pass, it would be a remarkable story, but would slow the anticipated deceleration in inflation because of the inevitable lift in wages growth that would result.

This is why the labour market data are an important input into the monetary policy deliberations.

In terms of the timing and magnitude of further interest rate rises, the next round of wages data will be critical.

In the middle of August, the Wage Price Index (WPI) and the even more important Average Weekly Earnings (AWE) data will be released.

The extent to which the tight labour market shows up in a further pick-up in wages growth will be revealed.

The best way to view these wages data will be to assess private-sector wages growth – public sector wages are likely to be held back as the wage caps put in place during the COVID recession will take a further few quarters to wash through those data, even though the private-sector wages data will be strong.

In addition, the AWE data will show the growth in cash incomes for workers, which can be impacted by people job hopping to higher-paid employers - something the WPI will not capture.

In many ways, the AWE will give a better reading than the WPI on real wages and debate on cost of living.

If, as is likely, private-sector wages growth is accelerating, more interest rate hikes from the RBA in the months ahead are assured.

At this stage, it looks likely the RBA will keep hiking in the next few months as it tries to get policy at a neutral setting, even though it may soon move back to 25-basis-point moves as the turning point in global inflation pressures continues to build.

A level for the cash rate around 2.75-3 per cent by year’s end seems a fair call at this stage.

After that sort of policy tightening is delivered, the RBA is likely to pause for a few months to see how tighter monetary policy is impacting on the economy.

There is a growing probability that, with global inflation topping out, this will be the peak of Australian interest rates in this cycle and that the first half of 2023 will see many months of steady interest rates as inflation pressures start to ease.

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