The Reserve Bank of Australia increased its cash rate by 25 basis points to 4.1% on March 17, aligning with market expectations. This marks the first instance of back-to-back rate hikes by the RBA since mid-2023 and partially reverses the 75 basis points of cuts implemented over a six-month period last year. The decision was approved by a 5-4 vote of the board.
In its policy statement, the RBA indicated that the Middle East conflict "could lift global and domestic inflation under a range of possible scenarios." Short-term inflation expectations have already risen, and inflation is likely to remain above the target band for some time. The bank emphasized the "substantial risk" of inflation staying elevated for an extended period.
The RBA committed to "do what is necessary" to achieve its price stability and employment objectives, stating that monetary policy is well-positioned to respond to evolving economic conditions. It also highlighted significant uncertainty surrounding the economic and inflation outlook, noting that future decisions will be data-dependent and consider the changing risk environment.
Most economists now anticipate the RBA could implement another 25 basis point hike in May, which would push the cash rate to 4.35% and fully retract last year's cumulative rate reductions. Following the announcement, the Australian dollar depreciated against the US dollar, and the yield on Australia's 3-year government bond fell by 9 basis points.
The central bank placed greater emphasis on external shocks in its assessment. The statement noted that the Middle East conflict has led to a sharp increase in fuel prices, presenting a significant risk that could fuel inflation both globally and domestically. Reports indicate that hostilities involving the US, Israel, and Iran, which began in late February, have drawn in over a dozen nations. The effective closure of the Strait of Hormuz, a critical passageway handling approximately one-fifth of global oil supply, has driven oil prices higher and poses a substantial upside risk to worldwide inflation.
In the fourth quarter of last year, the RBA's preferred core inflation measure remained high, significantly above the 2%-3% target range. Concurrently, the unemployment rate unexpectedly fell to 4.1%, 0.3 percentage points lower than the central bank's forecast.
GSFM investment strategist Stephen Miller stated, "Inflation is a real and present threat, and acting now with a rate hike is the most appropriate response. Failure to act could necessitate more aggressive policy measures in the future." Bank of America strategist Nick Stenner added that, with inflation persistently above target and facing upside risks, "holding rates steady would raise doubts about the central bank's commitment to controlling inflation."
Looking ahead to the May meeting, economists are weighing household cost pressures against inflation warnings. Prior to this meeting, economists from Westpac, National Australia Bank, Citigroup, and Deutsche Bank had revised their forecasts to predict a rate hike, with Westpac and NAB also projecting an increase in May. The CEO of Westpac suggested before the decision that households could likely absorb two additional 25 basis point hikes.
Concerns on the inflation front are also intensifying. Some economists warn that Australian CPI could reach 5%. Treasurer Jim Chalmers said on Sunday that households may face greater cost-of-living pressures and cautioned that inflation could rise above 4.5%. This outlook is higher than the RBA's February projection of a 4.2% peak for CPI this year, which was based on technical assumptions including crude oil prices remaining at $63.8 per barrel until mid-2028 and a cash rate of 4.2% by December 2026.
In the short term, markets will focus on the RBA's February employment report, due Thursday, and next week's monthly inflation data to assess whether another rate hike in May is likely.
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