RBA raises cash rate to 3.85%, warning inflation will remain above target for some time
RBA lifts cash rate 0.25ppt to 3.85% as expected, citing higher inflation and stronger growth in private sector demand.
- RBA Monetary Policy Board (MPB) raised the cash rate by 0.25ppts to 3.85% as forecast, citing renewed inflationary pressures coming from a faster recovery in private sector demand than expected. It assesses that the labour market remains a little tight, even though several standard indicators are moving in the easing direction.
- The RBA also published revised forecasts in its Statement on Monetary Policy (SMP). Growth is forecast to be stronger in the near term, and so is inflation. The upgrade to the inflation forecasts were large, and imply quarterly outcomes for trimmed mean inflation of around 0.9%qtr for the next two quarters before reverting to a more moderate 0.7%qtr track. At 3.2%, annual trimmed mean inflation is still forecast to be above target at end-2026.
- Beyond the middle of this year, the temporary elements in inflation are expected to unwind, and restrictive monetary policy to take hold. This will dampen inflation and allow it to return close to the mid-point of the 2–3% target range by the end of the forecast horizon in mid 2028. Also weighing on the inflation forecast would be the significant exchange rate appreciation since the last forecast round, though the RBA downplayed this.
- The Governor expressed some discomfort with the inflation profile still being above the 2.5% at the end of the forecast horizon. The July 2025 Statement on the Conduct of Monetary Policy states that when inflation is expected to be significantly away from the midpoint of the 2–3% target the Board will communicate how long it expects it will be before it again meets its objectives and why.
- The post-meeting statement was non-committal on whether further increases in the cash rate are needed, but the shape of the revised forecasts suggests that staff believe it is likely they will be. Given the feedback loop between inflation surprises and RBA assessments of supply, however, we believe it will pay to be more circumspect and do not expect a follow-up hike in March. But the MPB has set a low bar for further hikes and, should the RBA’s inflation forecast for March quarter be validated (which is highly plausible given our own view is only a little below this), it is likely to hike again in May.
As was widely expected, the RBA MPB raised the cash rate 0.25ppts to 3.85% at its February meeting. The recent run of underlying inflation data had been too strong for the MPB to look past, especially given that growth in private sector demand was stronger than expected, and the prior gradual easing in the labour market seemed to have paused or even ceased coming into year-end.
The RBA’s near-term forecasts for inflation have been upgraded noticeably, reflecting this assessment. While the RBA assesses that the bulk of the recent lift in inflation has reflected temporary factors (including some premature margin rebuilding on the back of stronger consumer spending that might not be sustained), some of it is seen as reflecting capacity pressures being tighter in late 2025 than previously assumed.
Over time, the RBA forecasts imply that the temporary component to the recent lift in inflation will unwind. In addition, tight policy will eventually take hold and bring inflation back down towards the midpoint of the 2–3% target range. The end-point of the forecasts at June 2028 show trimmed mean inflation at 2.6%. This implies that the RBA believes that the path for interest rates assumed in the forecasts delivers tight policy.
Since the previous forecast round in November, the exchange rate has also lifted noticeably. All else equal, this should dampen inflation further out, along with the tighter stance of policy. As an aside, we note that in the post-meeting media conference the Governor attributed most of this to a reaction to the shifting outlook for domestic interest rates. The SMP’s coverage of the sell-off in the USD was brief and did not discuss how this feeds through into the trade-weighted index also through its large weight on the Chinese currency. We think this underweights the disinflationary role the exchange rate could play in coming quarters.
In delivering tight policy, though, the RBA is forecasting a sustained period of soggy growth beyond the near term. GDP growth is expected to be below even the RBA’s pessimistic view of trend growth in supply capacity of around 2%. The unemployment rate is rising at the end-point of the forecast horizon, leading us to wonder if an extension of the forecast period would show inflation falling below the mid-point. This supports our view that, while the cash rate might be rising now, reductions can be expected in late 2027 or early 2028.
The RBA believes that the labour market is still on the tight side of full employment and did not ease further in recent months. While this is similar to our own assessment, we think the RBA is putting a lot of weight on the representativeness of some business surveys. Of the 15 indicators in the RBA’s standard suite for assessing labour market tightness, 11 eased and only 4 tightened, including two from business surveys.
The RBA assesses that supply capacity constraints are contributing to higher inflation, and that supply capacity was probably lower than previously believed. We have previously noted our scepticism about this assessment, given that the RBA’s assessments of trend productivity growth, population growth and (to an extent) trends in the participation rate are all systematically too pessimistic. We note that the discussion in the SMP attempts to show that productivity growth is low (and unit labour cost growth high) by comparing with a long-term trend that includes the late 1990s tech boom, a time when productivity growth ran at more than 2%yr and outstripped the rate in the United States. Excluding the mining sector, productivity growth is running at around 1%yr. The comparison in the SMP of the RBA’s assessment of the output gap with that of the OECD highlights just how consequential the judgement between cyclical and trend productivity growth can be.
The emphasis on supply capacity and the way assessments of it get revised in response to inflation surprises raise a deeper issue: every time the RBA is surprised by high inflation outcomes, it concludes that supply capacity must have been lower in the moment than it previously thought. While the RBA claims that it does not knee-jerk react to past inflation, this approach to analysis of supply capacity induces an indirect feedback loop from recent inflation surprises to its forecasts. By way of example, the recent data surprises have induced the RBA’s models to point to a lift in the NAIRU, the unemployment rate consistent with stable inflation. This then induces more assumed inflationary pressure from any given forecast profile for growth and employment.
In the post-meeting media conference, the Governor again highlighted the role of the Productivity Commission as the centre of excellence in identifying ways to lift productivity. While there are clearly policy levers that can be pulled, this puts all the onus on a policy-oriented view of how productivity growth occurs. Not enough attention is given to the role of capital accumulation or private-sector innovation more generally. The weak outlook for both dwelling and business investment in the RBA’s refreshed SMP forecasts provide no grounds for optimism on this front.
As is usual, Governor Bullock declined to provide any forward guidance on the future path of interest rates from here. Given that the forecasts imply higher inflation than the RBA is comfortable with even after raising rates, further rate hikes are clearly a possibility. However, we think the MPB will wait for another quarter inflation print to assess if things are playing out as expected. The low bar for further hikes means that, absent a downside surprise in the March quarter inflation outcome, the MPB is likely to hike again in May.
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