Commentary on Reserve Bank Board Interest Rate Decision - 7 February 2022

On 7 February, Australia had its own version of Groundhog Day with the RBA Board increasing the official interest rates by 25 bps to 3.35 percent. It was the ninth increase in a row.

With the domestic and global economy showing signs of slowing down, the RBA is watching the tight labour market closely. Regardless of what happens, the RBA is committed to more rate increases until they see inflation comfortably trending down to the target level of  2 to 3 percent.

What the RBA said

“In Australia, CPI inflation over the year to the December quarter was 7.8 per cent, the highest since 1990. In underlying terms, inflation was 6.9 per cent, which was higher than expected.”

“Inflation is expected to decline this year due to both global factors and slower growth in domestic demand. The central forecast is for CPI inflation to decline to 4¾ per cent this year and to around 3 per cent by mid-2025.”

“...  GDP growth expected to slow to around 1½ per cent over 2023 and 2024.”

“The Board expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target and that this period of high inflation is only temporary. In assessing how much further interest rates need to increase, the Board will be paying close attention to developments in the global economy, trends in household spending and the outlook for inflation and the labour market. “

Statement by Philip Lowe, Governor: Monetary Policy Decision, 7 February 2023.

https://www.rba.gov.au/media-releases/2023/mr-23-04.html

What to expect next

Has inflation peaked?

Last year, the RBA predicted that inflation would peak in December. So far that prediction is looking good with all the key inflation measures hitting new highs in December (see chart below).

Quarterly CPI increased from 7.3 to 7.8 percent on an annual basis. Weighted median inflation increased from 4.9 to 5.8 percent and the RBA’s favourite trimmed mean inflation increased from 6.1 to 6.9 percent.

Now we wait to see if inflation will start to come down in Janaury or February.

When we look under the hood of CPI, we can see that goods inflation decreased for the first-time since the June quarter in 2020: decreasing slightly from 9.6 to 9.5 percent in the December quarter. The impact of the pandemic on supply-lines and goods inflation is behind us now and the rising AUD against the USD will also have some deflationary impact on goods inflation.

Services inflation is a different story. It increased again in the December quarter and with the labour market so tight, it may still have room to run. We will all be paying close attention to the trend in wages. The Wage Price Index figures for the December quarter will be released on 22 February.

The labour market remains tight

Unemployment remained at 3.5 percent in December while the monthly hours worked increased by 1,890 million. Job vacancies decreased 4.9 percent in November but remains at historically high levels (see chart below). Together with the near record participation rate, this tells us that the labour market remains tight and that any significant increase in unemployment is months away.

However, the economy is slowing

GDP increased 0.6 percent in the September quarter down from 0.9 percent in the June quarter. And it looks like the December print will be lower still with business turnover down in eight of the 13 industries in November and retail turnover down -3.9 percent in December. A slowing economy will take the steam out of inflation and will loosen the labour market.

The international front

The US, EU, and UK all saw interest rate rises in January but talk has now turned from “how high for how long” to speculation on whether the terminal interest rate is in sight. The re-opening of China has already had a positive impact on Australia. 

Impact of the rate increase on the Australian Private Debt Market

With interest rates increasing again, private debt remains attractive. Further, given that 1-year government bonds have a yield greater than 2-year government bonds at the moment, private debt is even more attractive in the short-term.

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