MNI STATE OF PLAY: RBA Ponders Election-Eve Rate Rise

The Reserve Bank of Australia board meets on Tuesday, facing a scenario which most members would have thought unthinkable at the beginning of this year, the prospect of raising interest rates in the middle of a federal election campaign.

The unexpected momentum for inflation, however, which reached 5.1% in first quarter data released last week, has put significant pressure on the central bank to raise official rates for the first time in a decade from the current record low of 0.10%.

Underlying inflation, the RBA’s preferred measure, is now at 3.7% and is above the bank’s 2% to 3% target range for the first time since March 2010.

HISTORY

The last time the RBA raised rates in an election campaign was in 2007, and it was a controversial move as soon afterwards the Liberal-National Coalition was voted out of office after more than 11 years in power.

RBA board members go into the meeting with a similar prospect, with Prime Minister Scott Morrison’s Liberal Party-led coalition government still trailing behind the opposition Labor party in the polls, due on May 21, see: MNI INSIGHT: Market Rates Pricing Races Ahead But RBA Cautious.

Despite the political sensitivity of a hike in rates, RBA may decide that inflation needs to be checked as soon as possible, and that waiting any longer to raise rates could see inflation become even more difficult to control, as has been the case in neighbouring New Zealand.

WAGES ARGUMENT

The RBA has consistently pointed to a gap between wage increases and inflation as justification for leaving rates unchanged, but the momentum for inflation risks the likelihood that the gap could blow out.

Earlier expectations were for a rate rise in June, after the poll, but last week’s inflation data has injected some urgency into expectations of a policy response.

It is a long way from the RBA view at the beginning of the year, which was that a 2022 rate rise was unlikely and that it might be as late as 2024 before policy was tightened.

The RBA’s most recent Monetary Policy Statement, released in February, forecast underlying inflation at 3.25% in June, and then a fall to 2.75% by the end of the year as what it saw as temporary factors receded.

The next MPS is due on Friday and is likely to include significant revisions on the inflation forecasts. By that time, the RBA may have raised rates, with expectations of a 40 basis point rise tomorrow to take rates to 0.5% as the bank embarks on a tightening cycle.