Can Tighten Financial Conditions By Keeping Rates On Hold

The August 6 meeting minutes showed that the RBA Board felt that it could achieve the same tightening of financial conditions as a rate hike by holding rates steady longer than the markets had assumed. It remains concerned about the slow return of inflation to target and possible upside risks and as a result “it was unlikely that the cash rate target would be reduced in the short term.” The Board remains “vigilant” and even more data dependent given the uncertainty around its forecasts. Rates are likely to be on hold for some time.

• One of the key arguments for a rate hike was greater excess demand than originally believed. The minutes provide more details on this thinking. There had been a “reassessment of the economy’s current spare capacity” as well as an increase in demand expectations, which increased the gap between supply and demand, but estimates were “highly uncertain”. But this could have justified “an immediate increase” in rates.
• The risk of inflation not returning to target within a “reasonable timeframe” was also given as a reason for tightening, as the there was only limited “tolerance” of pushing the timing out further. Rates would have to be higher than market pricing used in the updated forecasts to “bring inflation sustainably back to target within a reasonable timeframe”. Policy appears to be on an extended pause.
• Other reasons for a hike were persistence of core inflation and cost pressures, and moderate easing in financial conditions.
• It opted to extend the pause as keeping rates unchanged would tighten financial conditions, balance the inflation/labour market risks, Q2 disinflation was broad based, inflation/labour market are expected to ease, uncertainties, market expectations & volatility, and insufficient data to warrant a change.