MNI STATE OF PLAY: RBA Could Take Rates To 2.5%, Says Lowe

Reserve Bank of Australia Governor Philip Lowe said on Tuesday that official interest rates could reach between 1% and 1.5% by the end of this year and as high as 2.5% as the bank enters a tightening cycle.

Responding to questions after the RBA increased the Official Cash Rate to 0.35% from a record low 0.10%, its first hike in over a decade and towards the upper end of expectations, Lowe said that it was “not unreasonable to expect” that the normalisation of monetary policy would see the OCR at 2.5%, although he declined to say how long it might take to get there.

“It will depend how long these issues (around inflation) resolve,” said Lowe. “There are reasons to believe that inflation will moderate, but the labour market is also tightening.”

Lowe said that that “we all knew interest rates couldn’t stay at these rates forever” and that it was now time to normalise policy and move away from emergency settings adopted during the pandemic.

“This is good news,” he said.

The RBA also announced that it will not reinvest the proceeds from maturing government bonds acquired during its recent bond buying program, with the expectation that the Bank’s balance sheet will decline significantly in coming years given that the withdrawal of the recent “extraordinary monetary support” is now appropriate.

The rate on Exchange Settlement balances, which are used to settle interbank transactions, will also rise by 25 basis points in line with the increase in the OCR, from the previous zero. Maintaining the 10-basis-point spread between the two rates was deemed to appropriate due to the continued high level of ES balances, in line with discussions mentioned in previous RBA minutes, Lowe said.

NOT BEHIND THE CURVE

Lowe said he did not accept that the RBA had been “behind the curve” on interest rates and that the Bank had wanted to see ample evidence before changing policy. He also declined to specify a level for neutral interest rates.

Lowe however said he had been “shocked” by the latest inflation data last week, which showed CPI inflation at 5.1% and underlying inflation, the bank’s preferred measure, at 3.7%, the first time it had been in the RBA’s 2% to 3% target range since December 2010.

The RBA’s move saw the AUD add USD0.01 to AUD0.71 to the dollar, and came as Australia is in the midst of a hard fought election campaign with polls set for May 21. (See MNI STATE OF PLAY: RBA Ponders Election-Eve Rate Rise.)

In response to questions, Lowe emphasised the independence of the central bank, with the RBA now expecting underlying inflation to reach 4.75% this year. This was based on an assumption of further interest rate rises, without which inflation would be higher.

FORECASTS UPDATED ON FRIDAY

The RBA’s most recent Monetary Policy Statement, released in February, forecast underlying inflation at 3.25% in June, followed by a fall back to 2.75% by the end of the year. The next statement, with updated forecasts, is due on Friday.

The RBA has insisted that wages growth would be key to any policy change, and Lowe said that this metric had risen above the 2% range and was “moving into the 3% range” based on evidence from the Bank’s liaison program.