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LUCI’S CALL: RBA hoping to ride out bumps in inflation

03:30pm May 08 2024

The Reserve Bank of Australia left the cash rate on hold at 4.35 per cent at its May Board meeting, as widely expected, while strengthening its language around the upside risks to inflation. 

Inflation is coming down, but not quite as quickly as the RBA wanted or had predicted. March quarter CPI was a little higher than expected and the labour market is somewhat tighter than expected. For these reasons, the Board did consider raising rates at the meeting.  

However, the Board has been mindful of the many uncertainties around the data. So while a further rate rise has not been ruled out we don't think it will come to that. In fact, the Board and the Governor have made clear that they hope it won't come to that either. 

Ultimately it comes down to whether inflation continues to surprise on the upside, or whether it continues to track down as we expect and the board is hoping.

Around the world, some central banks are poised to start cutting interest rates in the next few months while others are seeing sticky inflation and the timing of their likely rate cuts has been pushed out. That's also the case for Australia. Our disinflation journey started later than other countries, partly because we were later to open up after the pandemic.

We also seem to be facing an unusually tight labour market by historical standards and some homegrown supply issues, including in the construction sector. Some of these have also been driven by the unusual population surge after Australia reopened its borders, which is now turning around. For all of these reasons, the disinflation journey has been bumpy and will continue to be bumpy.

The RBA is going to have to look through these lumps and bumps and try to work out the underlying trend.

The current level of the cash rate is assessed as restrictive and is putting a squeeze on the economy. Households are reducing their consumption, which makes Australia an outlier compared to other countries where consumption has been stronger over time. 

This will translate into businesses finding it harder to pass on cost increases into their prices, and the indexation in some administered prices will slowly fade away in time. 

We maintain our view that inflation will come back to the target range of 2 to 3 per cent by late next year, similar to the RBA's own forecasts. 

While the central bank has upgraded their near-term forecasts for inflation, reflecting the surprise in the March quarter and some expectations of higher fuel prices in the June quarter, they left their forecasts for 2025 and beyond largely unchanged. 

That’s a signal that they’re viewing the recent lumps and bumps in the data as not yet a change in trend. So while rate rise is still on the table, the more likely outcome is that the rates are on hold until late this year or beyond.

For more detailed analysis from Luci on the RBA’s May Board meeting, visit WestpacIQ

Luci Ellis is Westpac’s economic spokesperson and is responsible for all of our economic research. She was previously Assistant Governor (Economic) at the Reserve Bank of Australia from December 2016 until October 2023. Prior to that, Luci was Head of Financial Stability Department at the RBA for eight years, spent two years on secondment at the Bank for International Settlements in Basel, Switzerland, and held several other senior positions at the RBA over a three-decade career in central banking. Luci has been a member of the Australian Statistics Advisory Council, the statutory advisory body to the Australian Bureau of Statistics, since November 2015. Luci holds a PhD from the University of New South Wales, a Masters in Economics degree from the Australian National University and a first-class Bachelor of Commerce (Honours) degree from the University of Melbourne.

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