Reserve Bank’s eleventh rate rise in twelve months

Australia’s RBA catches market by surprise with a 25 basis point increase in the cash rate to 3.85%

3 May 2023

Over recent months, RBA Governor Philip Lowe has come under pressure to provide greater clarity over the central bank’s bias in relation to the cash rate, yesterday’s decision caught the market off guard. Of the major banks, on the Commonwealth Bank priced in yesterday’s 25 basis point rise, 84% of economists predicted otherwise.

In a speech last night in Perth, Lowe indicated bringing inflation down to its target range of 2-3% remains the central bank’s top priority and the RBA is not on a “pre-set course” vis-à-vis rates, “I want to acknowledge that the combination of higher interest rates and other cost-of-living pressures is squeezing many people’s budgets and that it is a difficult time for many families. Real wages have fallen and those with high debt have experienced a very large rise in their mortgage payments. I want to assure you that the Board is very focused on understanding these pressures and we are taking them into account in our decisions.”

In a note to investors, AMP Capital market reports: The RBA has raised its cash rate by another 0.25% taking it to 3.85%. This was contrary to our own view and the consensus of economists where 26 out of 34 economists surveyed by Reuters expected no change. We had thought that the decline in inflation would have provided scope for the RBA to remain on hold again to better assess the outlook. This now makes 11 rate hikes since starting in May last year totalling 3.75%, or 375 basis points, which takes the cash rate to its highest since early 2012. The RBA retained its tightening bias, although it arguably softened it a bit. We think that the RBA has done more than enough and we have reached the peak in rates. Continuing to raise rates from here adds to the rising risk of plunging the economy into a recession. However, given high inflation, the still tight labour market and the RBA’s still hawkish guidance, the risks are still skewed to the upside for interest rates. However, by year end or early next year we continue to see the RBA starting to cut rates.

In hiking the cash rate by another 0.25% the RBA noted that while inflation has peaked, it’s still too high and is not expected to return to the top of the target range until mid-2025, services price inflation is still very high, the labour market remains very tight with rising unit labour costs and subdued productivity and there are upside risks to wages growth.

Given the high level of inflation it retained its guidance that further rate hikes “may be needed to ensure that inflation returns to target” but it noted that this depended on “how the economy and inflation evolve” potentially opening the window to a peak in rates depending on the economic data ahead. So its tightening bias is arguably a bit softer. It has indicated that it will continue to look closely at the global economy, household spending, inflation and the labour market.

In his speech last night by RBA Governor Lowe will no doubt shed more light on the RBA’s views.

The decision to hike rates again still leaves the RBA more cautious in raising rates than other comparable central banks arguably reflecting an allowance for the faster flow through of monetary tightening to households in Australia than in other countries and the RBA’s relatively greater focus on maintaining full employment and its desire to “keep the economy on an even keel.”

Banks are likely to pass the RBA’s rate hike on in full to their variable rate customers. This will take variable mortgage rates to their highest levels since early 2012.

A variable rate borrower with a $600,000 mortgage will see roughly another $99 added to their monthly mortgage payment from today’s RBA hike which will take the total increase in their monthly payments since April to around $1200 a month. That’s an extra $14,250 a year which is a massive hit to household spending power. Many of those on fixed rates will start to experience that increase this quarter and next. Don’t forget that the RBA estimates that 15% of variable rate borrowers will move into negative cash flow (with after tax income below essential living expenses and mortgage payments) by year end if the cash rate rises to 3.75% and we have now surpassed that.


In our view it would have made more sense to continue with the pause in rates and this was supported by confirmation that inflation fell in the March quarter. It takes time for rate hikes to fully flow through to spending and hence to inflation and not enough time has passed since the March hike to assess the impact of the ten prior hikes.

While we have underestimated how far the RBA would raise interest rates in this cycle, our assessment is that the cash rate is at or very close to the top:

  • there is increasing evidence that growth is slowing with stagnant retail sales since September, slowing momentum in indicators of overall household spending and falling job vacancies;
  • growth is set to slow further as rate hikes continue to flow through, indebted households’ prepayment buffers are falling, an increasing proportion of home owners are moving into negative cash flow and the reopening boost is starting to fade;
  • as growth slows this will further depress inflation which looks to have peaked last December; and
  • there is still no evidence of a wages breakout or a dangerous surge in inflation expectations.

Against this backdrop ongoing rate hikes risk unnecessarily plunging the economy into a recession we don’t have to have.

However, the risk of a further rate hike still remains high as inflation is still high and could prove sticky in falling, the risks to wages growth are on the upside which could add to services inflation or keep it higher for longer and stronger than expected population growth risks adding to housing related inflation and reversing the negative wealth effect from the fall in property prices.

Either way our assessment remains that by year end or early next year the RBA will start to cut rates to help the slowing economy as inflation starts to fall more than it expects.