Two weeks ago, Australia's central bank raised its key interest rate, citing that upside inflation risks were becoming reality and that waiting could prove costly, while adding that the outlook would be heavily shaped by the ongoing conflict in the Middle East.
In the minutes of its September meeting released on Tuesday, the bank said: "Members discussed the challenge of judging how large the upside risks to inflation were, or could become." It had previously lifted the key rate to 4.6%. The board will take the necessary actions to fulfill its mandate, "including raising the cash rate target further if necessary."
In discussing the rate hike, the central bank's board also noted that although Australia tightened policy earlier than other central banks, future movements in Australian interest rates relative to those of other countries would also affect the exchange rate and, in turn, domestic inflation.
The Reserve Bank of Australia has carried out the most aggressive tightening campaign among developed-economy central banks this year, raising borrowing costs by 1 percentage point in an attempt to curb stubbornly high inflation. Since late last year, Australia has faced renewed price pressures and had already begun raising the cash rate even before U.S. and Israeli strikes on Iran triggered a global energy shock.
The RBA is the most hawkish central bank in the developed world. Traders had priced in about a one-third chance of a November rate hike, rising to slightly above 50% by December, with the probability increasing further next year—expectations formed before the minutes were released.
The RBA listed three key reasons for its decision to raise rates at the end of last month: first, and most forcefully, several upside risks identified in its August economic forecast update had already materialized or were accumulating; second, responding to cost pressures in a timely manner would best balance its employment and inflation objectives. The board acknowledged that "waiting for further confirmation of the inflation outlook could prove costly"; third, the current cash rate may not be sufficient to bring the economy back into balance within a reasonable timeframe. If signals that the "global neutral rate may be rising" hold true, it would mean the 4.35% rate level is less restrictive than it was two years ago.
Since the meeting, the risk of the Middle East conflict widening further has grown—a wave of drone and missile attacks targeting Saudi Arabia has increased pressure on the United States to step up efforts to help its close ally strike Iran-backed Houthi forces in Yemen. This has injected fresh momentum into oil prices and inflationary pressures.
The RBA acknowledged that the trade-off between inflation and full employment has worsened, while insisting its goal remains bringing CPI back into the 2%–3% target range while preserving as much existing employment growth as possible.
The RBA said: "However, pursuing this strategy in an environment of more persistent adverse supply shocks would require accepting slower growth in demand and employment than would otherwise have been the case."
"Members added that the board's task is to stabilize medium-term inflation at the target, even if the persistence of medium-term inflation is driven in part by factors beyond the influence of monetary policy."
In a brief explanation of the reasons for holding rates steady last month, the RBA noted that this was mainly based on the possibility that downside risks to employment and activity could be greater than expected. One reason may have been that "members judged that the impact of falling housing prices on household spending could be larger than assumed."
Australia's property market downturn is deepening, with national home prices in September falling back to levels recorded a year earlier amid weak buyer demand. As households face high borrowing costs, rising oil prices and persistently strong inflation, consumer confidence is also sliding.
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