RBA and BoE get tough on inflation

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On Tuesday, the RBA decided to increase the cash rate target by 50 basis points (bps) to 1.85%.

IT was another busy week for most central banks in the world, including the Reserve Bank of Australia (RBA) and the Bank of England (BoE).

On Tuesday, the RBA decided to increase the cash rate target by 50 basis points (bps) to 1.85%. This marked the fourth rate increase made by the central bank after a 50-bps rate hike in July and June, and 25 bps in May.

The news on the interest rate hike by the RBA was expected by the financial market, but it was an unwelcomed one as the exchange rate of the Australian dollar against the US dollar declined by 1.31% to 0.6925 after the announcement.

Inflation concerns were the prime reason for the aggressive move by the RBA.

As of the second quarter this year, inflation in Australia stood at 6.1%, way above the RBA’s inflation target mandate of 2% to 3% target.

High commodity prices

Both external and domestic factors were the contributors for the high inflation in Australia.

From the global side, the higher commodity prices led to the price pressure on overall prices for goods and services in Australia.

Most notably, prices for food rose by 5.9%, and prices for transportation, which reflected energy prices, increased by 13.1%, the highest in 20 years.

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On the domestic side, the tight labour market was also a contributing factor to the high inflation. As of June 2022, Australia’s unemployment rate stood at 3.4%, which is the lowest reading ever recorded by the Australian Bureau of Statistics.

Total job vacancies are also at its highest, where there around 461,000 jobs are still available, higher than the pre-pandemic trend of around 200,000 vacancies.

To minimise price pressure from the demand side, given that the labour market is tight, the RBA took an aggressive approach by making a 50-bps rate hike.

Given that the world commodity prices have cooled recently due to the higher interest rate environment that dampens demand, plus pessimistic global economic outlook toward the end of the year, it is likely that oil prices will remain at the current level for a considerable period of time.

This means that inflation in Australia, if no further disruptions happen, will recede soon.

There were also concerns on the Australian real estate market.

House prices in Australia are highly sensitive to the movement of the mortgage rate. Between March 2020 and March 2022 when the lending rate for housing loans was at its lowest, the residential price surged by 33.2%.

Since its monetary policy contraction plan started, the house price increase was much slower, suggesting that appetite for residential properties has cooled.

The concern is that if interest rates continue to rise, the residential price will become flat, or eventually decline.