The upwards cycle in the Reserve Bank of Australia’s monetary policy continues this month with a 50 basis point hike, bringing the cash rate to 0.85%.

RBA Governor Philip Lowe said one of the key drivers behind the decision is the significant increase in inflation due to global and local factors.

“While inflation is lower than in most other advanced economies, it is higher than earlier expected,” he said.

“Inflation is expected to increase further, but then decline back towards the 2–3 per cent range next year. Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago.”

Mr Lowe also noted the strong conditions in the labour market, with employment growing significantly and the unemployment hitting its lowest in almost 50 years.

All of these are on the back of a resilient Australian economy, which grew by 0.8% in the March quarter and 3.3% over the year.

However, one source of uncertainty is how household spending evolves in response to the higher inflation.

“Housing prices have declined in some markets over recent months but remain more than 25 per cent higher than prior to the pandemic, supporting household wealth and spending,” Mr Lowe said.

“The household saving rate also remains higher than it was before the pandemic and many households have built up large financial buffers.”

Mr Lowe said this recent hike indicates that the extraordinary monetary support that was put in place to help the Australian economy during the pandemic is no longer needed.

“The 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,” he said.

Creditorwatch chief economist Anneke Thompson said today’s increase in the cash rate reflects the RBA’s increasing concern about the inflation rate, which surged to 5.1% over the first quarter of the year.

“Senior executives in the grocery, construction and logistics sector have recently been advising their customers to continue to expect prices to rise, as many products have not yet been fully repriced,” she said.

While the new Labor Government has shown their support behind an increase in the minimum wage to match the latest inflation figure, the decision still rests with the Fair Work Commission.

“There is a general consensus among economists that workers on minimum wage need a relatively generous pay increase to keep up with price rises and rising home loan rates — if real wages go too far backwards, the risk of recession and rising unemployment rises significantly,” Ms Anneke said.

Impact on house prices

PropTrack economist Paul Ryan said the higher interest rate expectations have weighed on housing price growth across the country in 2022.

“Housing price growth has slowed significantly, with annual price growth falling from 24% six months ago to only 14% in the year to May,” he said.

“This slowdown has particularly affected the most expensive capital markets of Sydney, Melbourne and the ACT, which recorded price falls in May.”

Mr Ryan said more rate increases are expected this year, especially as inflation continues to be higher than anticipated by the RBA.

However, just how high the cash rate would go at the end of the year remains a key source of uncertainty for the market.

“Financial markets have priced in a cash rate two-percentage points higher at the end of the year, which would raise mortgage repayments by another 24%,” he said.

“Major bank forecasters, however, do not view it likely the RBA will increase rates this quickly, predicting rate rises closer to half that much.”

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