May interest rate announcement: RBA raises official interest rate for the first time in 11 years

Australia’s official interest rate has jumped to 0.35 per cent in its first rise in nearly 12 years and after sitting at the historic low of 0.1 per cent for the past 18 months.

The May meeting of the Reserve Bank of Australia (RBA) on Tuesday voted to lift the cash rate target by 25 basis points as a response to the shock increase in inflation.

RBA governor Philip Lowe said now was the right time to begin withdrawing extraordinary monetary support put in place to help the economy during the pandemic, and signalled further lifts to interest rates in the coming months.

“The economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than was expected,” he said in a statement.

“There is also evidence that wages growth is picking up,” he said, citing evidence from the Bank’s business liaison. “In a tight labour market, an increasing number of firms are paying higher wages to attract and retain staff.”

The latest inflation data from the Australian Bureau of Statistics revealed that the Consumer Price Index rose 5.1 per cent over the 12 months to the March 2022 quarter, the highest growth in two decades.

“Back during COVID, the inflation rate was 1.9 per cent, so you could almost call this ‘galloping’ inflation,” said PRD Real Estate chief economist Dr Diaswati Mardiasmo.

“The bank also wants to see wage growth of 3-4 per cent but our last figures back in December put it at about 2 per cent. But we do know, anecdotally, that there has been some wages growth in the last couple of months because the labour market has been very tight, especially in the construction industry.

“We also know that the last time the bank put up rates in November 2010, that was the seventh rise in just over 12 months, taking the cash rate from 3.25 per cent to 4.75 per cent, so we can expect other rises now to come quite quickly.”

Even though the wages growth figures won’t be issued until May 18, the bank had to act now to cool the economy, agrees St George Bank economist Matthew Bunny. With that sudden steep rise in CPI, they had little alternative.

In addition, the interest-rate markets priced in the probability of a rate rise, predicting the cash rate to be around 2.5 per cent by the end of the year. Australian three-year and 10-year bond yields lifted six basis points to 2.88 per cent and 3.19 per cent in anticipation.

“With the strength of the inflation figure, it wasn’t appropriate for the interest rate to stay the same,” said Mr Bunny. “It was just so much stronger than the RBA had forecast and it looks like running even higher, and they have to respond to economic conditions.

“The RBA has also been keen to emphasise its independence from politicians too and has said the imminent election shouldn’t be a factor in its decision-making. Interestingly, though, the last time there was a rate hike during an election, we had a change of government, in 2007 when Labor’s Kevin Rudd defeated the incumbent Liberals under John Howard.”

Import prices jumped 5.1 per cent over the March quarter, following a 5.8 per cent increase in the December quarter, St George reports, largely attributed to higher prices for petrol products following the invasion of Ukraine. 

Surging inflation was also a consequence of rising transport, housing and building costs, says David Hyman, chief executive of the Lendi Group.

“As a result of that inflation figure, we all expected this rate rise in May,” he said. “We’ve been at emergency interest rate settings off the back of the pandemic, and they can’t stay there. So, now inflation has gone beyond the target range, it was appropriate to raise the cash rate.

“We don’t have any firm data yet on wage growth, but anecdotally we believe it’s going up, so it’s the RBA’s job to use monetary policy levers to get the economy within the target range. We may see the rate going up by 200-250 basis points [to 2.1 per cent or 2.6 per cent] over the next 12 months.”

Mr Hyman believes the rate rise will likely cool the heated housing market too, in terms of both house prices and volumes. With many of those in the market never having seen a rate rise before either, he forecasts many will end up reviewing their mortgages to find better lender rates. 

But economist Nicholas Gruen of Lateral Economics says it will be a tricky act for the RBA to be careful not to tip the economy into recession. “We have a very different economy now,” he said. “It’s much more indebted and fragile, and we have no idea how asset-holders will react to an increase in rates.”

PRD’s Dr Mardiasmo, on the other hand, says that history suggests buyers react to a rates rise by actually entering the market, in fear of another cash rate hike before their borrowing power lessens still further.   

“We currently have a lot of demand because of COVID restrictions, government home-ownership grants and demographic changes, and that’s without international demand coming back into the fray again,” she said. 

“We still have supply issues too, so that might create even more of a time lag between this cash rate rise and any effect on property prices.”