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OPINION: RBA is playing catch up, but more work needs to be done

Compilation image of people walking, RBA sign and Australian flag flying
Even at 0.85 per cent, Australia's cash rate is still low given the current economic outlook. (Source: Getty)

In response to the certainty of inflation moving to a 30 year high above six per cent and with the unemployment rate a staggeringly low at 3.9 per cent and set to fall further, the Reserve Bank of Australia (RBA) increased official interest rates for June by 0.5 percentage points to 0.85 per cent.

It signalled that there are more interest rate rises to come given the extreme imbalances in the economy.

Also by the Kouk:

This is being fuelled by massive fiscal and monetary policy stimulus put in place in response to the COVID pandemic and not withdrawn as inflation pressures smouldered and then ignited.

The RBA is also aware of the wages pressure building in the private sector and how this will help support household spending and put a floor under the inflation rate over the medium term.

Even with the 50 basis point move, it is clear the 0.85 per cent cash rate is still ridiculously low given current economic conditions and the outlook.

The interest rate was around this level in 2019 when Australia's gross domestic product (GDP) growth was 1.5 per cent, inflation was below two per cent with little prospect of accelerating and the unemployment rate was stagnant at around 5.25 per cent.

What an amazing transition to the state of the economy today.

Having been slow to start the hiking cycle, the RBA is now hoping to play catch up with this move and it is signalling that there will be more interest rate hikes to come.

In announcing the interest rate rise, RBA governor Phillip Lowe mentioned that “capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices”.

Inflation, in other words, is coming from an overheated economy.

It remains an open debate where the cash rate will peak as this hiking cycle continues to unfold in the months ahead. Money market futures are pricing the official cash rate to peak at around 3.5 per cent in late 2023, such is the pressure on the RBA from the surge in inflation both domestically and overseas.

Whether this comes to pass will be determined by the speed at which inflation comes back under control, which at the moment looks to be later rather than sooner.

Recall that the RBA has a target for inflation of between two and three per cent and the current market forecasts are for inflation to hit seven per cent or more by year end.

This will be the biggest ever miss for the RBA.

It also goes to show how much work the RBA has to do to get inflation back to its target range.

The Albanese government has a role to play too with fiscal policy needing to be tightened to take some pressure off inflation, but to also repair the budget.

Treasurer Jim Chalmers will deliver the budget in October in which a renewed fiscal strategy will be outlined. Expect to see an overall tightening in fiscal policy designed to take some heat out of the overheated economy.

But the final words on the outlook for interest rates and the near certainty of more increases to come should be left to RBA Governor Lowe:

“The [RBA] Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board's assessment of the outlook for inflation and the labour market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”

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