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      News|3 May 2022

      Anchors away – RBA change course and raise rates

      Sean Langcake
      Sean Langcake
      Head of Macroeconomic Forecasting, OE Australia
      Anchors away – RBA change course and raise rates
      • The RBA has opted to raise the cash rate target to 0.35%. For some time, the RBA identified faster wage growth as its trigger for raising rates. Official data sources have provided no new information on this front over the past month. But the board has put their faith in information from the RBA business liaison program that wage growth is picking up.
      • As noted by the RBA, inflation pressures at present are primarily being caused by global and domestic supply disruptions, which are expected to abate. Higher interest rates will do little to cool inflation caused by negative supply shocks. Today’s move is about trying to control inflation expectations and signal the RBA’s tolerance for an inflation overshoot is limited.
      • Today’s cash rate move will be the first of several over the remainder of 2022; we expect the cash rate will be at least 1% by the end of the year. The forthcoming Statement on Monetary Policy will shed more light on the RBA’s current reaction function; a significant upgrade to their inflation outlook has been foreshadowed.

      In concert with raising rates, the RBA has announced it will shrink its balance sheet, effectively tightening monetary conditions over the next few years. The RBA’s balance sheet expanded considerably through the pandemic due to the Term Funding Facility, QE and yield curve control programs. Although new asset purchases ceased some time ago, there was still a choice to either maintain the size of the balance sheet or allow it to shrink as assets mature; by choosing the latter, the RBA has opted for tighter policy.

      Moving the cash rate target to 0.35% is a slightly curious move that defies the RBA’s conventional target structure and previous guidance. The rate paid on bank balances has been lifted from 0% to 0.25%; the cash rate has traded closer to this floor rate than its target through the pandemic due to excess liquidity in the financial system. We expect the cash rate will trade at a slight premium to the floor rate for now, but it will converge back toward target over time alongside the attenuation of the RBA’s balance sheet.

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