Australia’s central bank boosts interest rates by 50 bps

As it tries to contain increasing inflation, Australia’s central bank raised interest rates for the first time in 22 years on Tuesday, signalling that more tightening is on the way. The move stunned markets and sent the local dollar soaring.

The Reserve Bank of Australia (RBA) raised its cash rate by 50 basis points to 0.85 percent at the end of its June policy meeting, surprising investors who had expected a move of 25 or 40 basis points. In a statement, RBA Governor Philip Lowe said, “Given the current inflation pressures in the economy and the still very low level of interest rates, the Board decided to move by 50 basis points today.”

“The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead.”

The central bank had already raised rates by a quarter point in May, the first time it had done so since 2010, and many expected it to continue to do so in quarter-point increments.

The last time it increased by more than that was in the early 2000s.

The local currency rose 0.4 percent to $0.7223, while three-year bond yields jumped 16 basis points to 3.27 percent, the highest level since early 2012.

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Following the release of second-quarter inflation numbers, which are projected to be hot, futures changed to price in the genuine chance of another 50 basis point rise in July and rates around 1.5 percent by August.

Consumer price inflation touched a 20-year high of 5.1 percent in the first quarter and is expected to surpass 6% this quarter as energy, food, rents, and home construction prices rise.

“Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago,” Lowe warned.

Treasurer Jim Chalmers warned Australians in his third week in office that inflation will worsen before improving, and that they should expect a “difficult and expensive” winter.

Chalmers pledged that a budget focused on child care and health care will contain some cost-of-living assistance.

In late May, the Labor government defeated the Liberal National coalition in an election, inheriting about A$1 trillion in debt and endless budget deficits.

With inflation expected to remain high for longer, investors expect the RBA to hike rates to near 3% by the end of the year, making it one of the most aggressive tightening campaigns in history.

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Given that house-hunting Australians are saddled with A$2 trillion in mortgage debt, they are extremely sensitive to borrowing costs, most economists doubted rates would rise that far.

Following a fantastic run in 2021, house prices in Sydney and Melbourne have already begun to fall, and consumer sentiment has returned to epidemic levels.

“Consumer sentiment has never been this low at the beginning of an RBA tightening cycle,” noted Gareth Aird, head of Australian economics at CBA. “It was also the first time house prices have fallen at the start of a cycle, and house prices matter,” he added.

“Pushing rates too high too quickly runs the risk of prices correcting sharply lower in the near term which would have a ripple effect through the economy.”