Reserve Bank hikes interest rates against backdrop of increasing inflation

The Reserve Bank of Australia (RBA) has lifted the country’s official interest rates by 50 basis points or half a percentage point, taking the cash rate target to 0.85% and beating the expectations of most economists.

It is the biggest one-off rise in more than two decades and the largest increase to the cash rate in a single month since the year 2000.

The RBA move returns the cash rate to its highest level since September 2019.

RBA Governor Philip Lowe announced the increase against a backdrop of inflation which had been booming since the start of the COVID-19 pandemic.

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

“Global factors, including COVID-related disruptions to supply chains and the war in Ukraine, account for much of the increase but domestic factors are playing a role too, with capacity constraints in some sectors and a tight labour market contributing to upward pressure on prices.”

He said the interest rate increase was to assist with the return of inflation towards the 2% to 3% range.

Pandemic support

Further rate rises are expected in coming months as the bank moves away from its “extraordinary” pandemic support which pushed rates to historic lows of 0.1%.

The resilience of the economy and higher inflation means this support is no longer needed.

“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 said.

“As global supply problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate.”

Global outlook

Mr Lowe said the RBA will also pay close attention to the global outlook, which remains clouded by the war in Ukraine and its effect on energy and agricultural commodities pricing.

“Real household incomes are under pressure in many economies and financial conditions are tightening, as central banks withdraw monetary policy support in response to broad-based inflation,” he said.

“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 incoming data and assessment of the outlook for inflation and the labour market.”

Economists have noted that the latest rate rise is the biggest hike in 22 years and the first back-to-back rate hike since May 2010.

In early May, the RBA lifted Australia’s official cash rate by 25 basis points to 0.35% from 0.1%.

Experts believe the cash rate could hit 2.5% within the next 18 months.

Difficult news

Federal treasurer Jim Chalmers described the RBA’s decision as “difficult” news for homeowners, while warning that inflation would get worse before it gets better.

He acknowledged the rate hike would hurt homeowners already struggling with a “skyrocketing” cost of living and assured Australians of better times ahead.

“We need to be honest and upfront about the nature, severity and magnitude of this inflation challenge that we confront,” Mr Chalmers said.

“This cost of living crisis has been brewing for the best part of a decade it will take more than two-and-a-half weeks to turn around.”

Banks’ decision

Three of Australia’s big four banks are yet to announce their response to today’s news.

Westpac (ASX: WBC) has led the way by confirming it will pass on the rise to mortgage holders.

“From 21 June, will increase home loan variable interest rates by 0.50% per annum for new and existing customers,” it said in a statement.

Announcements from the Commonwealth Bank (ASX: CBA), ANZ (ASX: ANZ) and National Australia Bank (ASX: NAB) are expected to follow.

If passed on in full by the banks, the interest rate rise will add approximately $133 per month to repayments on a home loan worth $500,000 over 25 years, and $265 a month on a loan worth $1 million.