On the afternoon of May 2nd, 2023, the Reserve Bank of Australia (RBA) announced a 25 basis point increase in interest rates, bringing the cash rate to 3.85%. This is the 11th interest rate hike since May 2022.
When the RBA stopped raising interest rates in April, most people finally breathed a sigh of relief and based on the inflation data released again, everyone thought the Reserve Bank of Australia would continue to keep rates unchanged. Yesterday’s rate hike did catch many people in the market off guard.
Alright, let’s discuss this unexpected rate hike.
According to the review of the Reserve Bank of Australia (RBA) by the Federal Treasury, the overall reason for the rate hike is still related to inflation.
The RBA is not satisfied with the magnitude and speed of the current inflation decline, and we can analyze this from two aspects.
The local service industry in Australia
Although overall inflation in Australia has started to decline recently and commodity prices have fallen, the price decline in the service industry is not significant.
Australian Labor Market
The Australian labor market remains tight, with labor shortages being an important factor. Due to the tight labor market, wage growth has been high, and labor prices remain high, which has made it difficult for inflation to decrease rapidly.
Overall, in addition to the inflation rate itself, we also need to pay attention to the service industry and labor market, which indirectly led to the unexpected rate hike and interest rate increase. The service industry has not seen a significant decrease in prices, while the tight labor market has resulted in a shortage of labor and high wage growth, which has kept labor costs high and prevented inflation from declining quickly.
After the news of the rate hike was announced, the Australian stock market immediately experienced a sharp drop, and the Australian dollar also rose by around 1% in a short period of time. These factors are sufficient to illustrate that this rate hike was unexpected by the market.
In late April, the Australian federal government conducted an independent review of the Reserve Bank of Australia (RBA), and the review report recommended reforms to the RBA, which were related to the central bank’s monetary policy mechanism. It suggested that the central bank should be restructured, with a dedicated committee for monetary decision-making and a governance committee.
The report recommends that after the split, the central bank can make more sustainable decisions in monetary policy, including transparency in external communication and the frequency of central bank monetary policy meetings. Currently, the Reserve Bank of Australia meets once a month, with the only break in January. The report recommends reducing the number of meetings from 11 to 8 per year, and keeping them closely related to the release of inflation data and other important core economic data in terms of timing.
The formulation of monetary policy requires a lot of economic practice, market reactions, and accurate judgments on macroeconomic factors, which require a lot of macroeconomic talents and expertise. However, according to the review, some of the external members of the nine-member board of the Reserve Bank of Australia (RBA) lack professional knowledge, making the review process difficult, and began to question the RBA staff’s advice on interest rates and the financial and economic judgments they were based on. Internal governance requires more business management talents, and the existing board of directors of the RBA lacks supervision over the bank’s governance decisions, while the governor has too much power in managing the bank. It is expected that after the reform, board members and the governor will jointly assume responsibilities and obligations for the bank and its decisions. From the perspective of splitting up, the efficiency of the RBA’s implementation will be improved after the reform.
Overall, the economic impact of the May rate hike is significant. It is expected that household spending in Australia will decrease for the entire year of 2023, while business investment will remain relatively stable. Social demand is expected to decline in 2023 and is expected to recover in 2024. With the decline in inflation, disposable household income is expected to increase in 2023. However, the slowdown in employment will continue until the end of 2024.