RBA pauses on rates

After ten consecutive cash rate rises, Australia’s Reserve Bank leaves rates on hold at 3.6%

4 April 2023 | Staff Writers (Image: Marcus Reubenstein)

The Reserve Bank has kept Australia’s cash rate on hold, in a note to investors, AMP Capital economist, Diana Mousina says, The Reserve Bank of Australia (RBA) left the cash rate unchanged at 3.6%, as expected by us, most economists (19 out of 30 economists surveyed by Bloomberg expected no change today) and financial markets. After 10 consecutive increases to the cash rate, this is the first pause in interest rates since the hiking cycle started in May 2022. The RBA has hiked interest rates by 3.50% or 350 basis points, which surpasses all of the tightening cycles since the 1990s.

The cash rate is currently at its highest level since May 2012. Discounted variable mortgage rates and fixed mortgage rates are also their highs since 2012. Some fixed rates have started falling recently as markets are pricing in interest rate cuts by the end of the year.

The RBA’s decision to keep interest rates unchanged today was justified because of the lags involved with monetary policy changes, with the RBA noting that the full effect of rate hikes is yet to be felt and that it needs additional time to assess the impact of higher interest rates. We think that this is the right decision. The data flow over recent months has showed some moderation in economic activity (slowing in consumer spending, poor lending growth, low levels of housing construction, deteriorating business surveys and low consumer sentiment) along with a downtrend in inflation. Another interest rate hike would risk sending the economy into a deeper slowdown and risk a recession which is not necessary to get inflation down (as it is already slowing).

On the banking issues in the US and Europe the RBA commented that this has resulted in volatility in financial markets and a reassessment of the outlook for interest rates as well as an expectation that financial conditions would be tightened. The banking issues would have factored into the RBA’s deliberations as the issues in the banking sector are a perverse impact of monetary policy tightening.

The RBA retained its tightening bias noting that “the Board expects that some further tightening of monetary policy may well be needed to ensure that inflation returns to target” although this is softer than last month’s statement “the Board expects that further tightening of monetary policy will be needed”. It makes sense for the RBA to maintain its tightening bias, as it needs to sound tough on inflation (which is still way too high, running at 6.8% year on year to February) because it does not want to risk a significant rebound in economic activity off the back of a pause in interest rates. However, our view is that the data flow will continue to disappoint to the downside in coming months and further rate rises won’t be justified. Further financial contagion from the banking sector issues also can’t be ruled out which would also justify keeping interest rates steady. By the end of the year we still expect the RBA to start cutting the cash rate.

However, with the current level of inflation still way above the RBA’s 2-3% inflation target, the risk lies with another interest rate increase in coming months if overall economic data doesn’t slow like we expect. But don’t forget that monetary policy works with significant lags. For example, as at February, only around 64% of the RBA’s interest rate increases (or 2.09% out of 3.25%) had been passed on to outstanding mortgages (see the chart below) which reflects the lagged impacts of repayment changes for households on variable rates and the large share of households on fixed rates that are yet to roll-off.