RBA Holds Rates Steady But Warns Further Hikes May Be Needed To Tame Inflation

The Reserve Bank of Australia (RBA) decided to keep the official cash rate unchanged at a 12-year high of 4.35% at its February meeting, but warned that further rate hikes may still be warranted if inflation does not continue easing as expected.

RBA Shifts To More Neutral Stance While Remaining Vigilant On Inflation

In a statement released after the rates decision, RBA Governor Michele Bullock said the central bank’s board believes it has made good progress on bringing inflation back to target but is not yet confident that inflation is on a sustainable path back to the 2-3% range.

“The Board recognises that monetary policy operates with a lag and that the full effect of the increase in interest rates is yet to be felt in mortgage payments. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that,” Bullock said.

This marks a slight shift from the RBA’s previous forward guidance which explicitly stated that further rate rises would likely be needed. The change in tone suggests the RBA is now adopting a more data-dependent neutral stance, but remains hawkish and prepared to hike further if needed.

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Bullock reiterated several times that the RBA was paying close attention to the evolution of the inflation data and labor market indicators over the coming months.

“The Board will assess how developments balance out as it sets policy to make sure inflation returns to target while keeping the economy on an even keel,” Bullock noted.

December Quarter Inflation Cools Faster Than Expected

The shift in the RBA’s stance comes after official data last week showed Australia’s headline inflation eased sharply to 6.9% in the December quarter from 7.8% in the September quarter. This marked a steeper deceleration than the RBA was anticipating and provides some tentative evidence that inflation may have peaked.

However, Bullock emphasized that much uncertainty remains around the inflation outlook. She specifically cited ongoing pressure from domestic services inflation and the potential for renewed supply-side disruptions from China’s reopening and extreme weather events domestically.

Markets, Economists Split On Timing of Rate Cuts

In response to the softer inflation data and shift in RBA guidance, markets have pulled forward expectations for when rates could start being cut. Overnight index swaps now imply roughly 50 basis points worth of cuts priced in over 2023, with some chance of cuts emerging late this year.

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However, most economists believe rate cuts this year are unlikely given ongoing inflation pressure.

“We expect underlying inflation to settle above 3% for all of 2023 before potentially approaching the target band in 2024,” said Callam Pickering, APAC Economist at global jobs site Indeed. “That suggests rate cuts are at least six months away, if not longer.”

ANZ senior economist Felicity Emmett concurred, saying “There’s still plenty of inflation in the pipeline over 2023. We don’t expect rate cuts until 2024.”

Further Tightening Would Risk Recession, Analysts Warn

While staying alert on inflation, the RBA also slightly downgraded its forecasts for economic growth in remarks following the rates decision.

Bullock said GDP growth is expected to slow to around 1.5% over 2023 and 2024 due to the lagged effects of monetary policy tightening. She warned that going too hard on rate hikes could severely impact confidence and spending.

“Higher interest rates do have a contractionary effect on spending, given the impacts not just from higher mortgage payments but also from reduced borrowing and spending by businesses,” Bullock explained.

Analysts agreed that slamming too hard on the brakes now would be counterproductive, especially with leading indicators of economic activity already looking fragile.

“It’s clear that rate hikes are really starting to bite in the economy,” said Pete Wargent, co-founder of BuyersBuyers. “Taking the cash into restrictive territory risks inducing a recession, which would only create a fresh set of problems for the RBA.”

Outlook Remains Uncertain As Global Risks Loom

In her concluding remarks, Bullock stressed the high uncertainty in the outlook, both on inflation and growth. This means the risk of policy errors in either direction remains elevated.

On the upside, renewed supply disruptions or wage pressures could keep inflation too high for comfort, necessitating more tightening. But tighter policy could also induce a deeper global downturn that drags Australia into recession.

“There are complex trade-offs to be had here and no easy answers on the best path forward,” said Danielle Wood, CEO of the Grattan Institute. “The RBA has bought itself some breathing room with this decision, but risks remain firmly skewed to the downside for both inflation and growth.”

So while the RBA has turned more neutral in its stance for now, further volatility in interest rates over 2023 remains likely as the central bank balances rising recession risks against still-high inflation. Another year of uncertainty awaits Australian mortgage holders and the economy more broadly.

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