RBA: Monetary Policy Minutes for May 2022

May 3: The Board decided to increase the cash rate target by 25 basis points to 35 basis points and to increase the interest rate on Exchange Settlement balances from zero per cent to 25 basis points.

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Considerations for monetary policy

In considering the policy decision, members noted the underlying strength of the Australian economy and its ongoing resilience. The monetary and fiscal policy measures that had been put in place to support the economy through the pandemic, alongside the rapid development of COVID-19 vaccines, had contributed to this positive outcome.

The Australian economy was being supported by household and business balance sheets that were generally in good shape, an upswing in business investment and a large pipeline of construction work. Macroeconomic policy settings also remained supportive of growth and national income was being boosted by higher commodity prices.

The resilience of the Australian economy was particularly evident in the labour market. Members noted that the unemployment rate had declined over prior months to multi-decade lows and labour force participation had increased to a record high. The Bank’s central forecast was for a further decline in the unemployment rate to around 3½ per cent by early 2023. Members noted that aggregate wages growth had been subdued during 2021 and was no higher than prior to the pandemic. However, more timely evidence from liaison and business surveys indicated that labour costs were rising in a tight labour market and a further pick-up was likely over the period ahead.

Inflation in the March quarter had increased substantially and was above the target range of 2 to 3 per cent. Although the rise in inflation largely reflected global factors, members noted that strong domestic demand and capacity constraints were also playing a role. This was evident in the broadening of inflationary pressures, with firms more prepared to pass through cost increases to consumer prices. Inflation was expected to increase further in the near term but decline back towards the top of the target range by mid-2024 as supply-side disruptions are resolved. These forecasts were based on a technical assumption of the cash rate increasing to around 1¾ per cent by the end of 2022 and around 2½ per cent by the end of 2023.

The Board considered whether the condition that it had earlier set for an increase in the cash rate had been met. This was for actual inflation to be sustainably within the 2 to 3 per cent target range, which was likely to require a faster rate of wages growth than had been experienced over the preceding years.

Inflation was now above the target and was not forecast to return to the target range until mid-to-late 2024. While the significant rise in inflation had been largely the result of global factors, which were likely to have a more temporary effect on inflation, the flow of information on inflation and wages over the preceding month had been consistent with more persistent inflationary pressures arising from limited spare capacity in the domestic economy. Members observed that it would be more difficult to return inflation to the target if the inflation psychology in Australia were to shift in an enduring way.

Members considered whether it was necessary to wait for March quarter data on the Wage Price Index and broader measures of wages growth from the national accounts to be published. They agreed that this information would be helpful; however, the recent evidence on wages growth from the Bank’s liaison and business surveys was clear.

Members agreed that the condition the Board had set to increase the cash rate had been met. They also agreed that further increases in interest rates would likely be required to ensure that inflation in Australia returns to the target over time. In making its decisions, the Board agreed that it will continue to be guided by the evidence on both inflation and the labour market, while noting that significant uncertainties remain.

Globally, it was not yet clear how the various supply-side problems will be resolved. Domestically, there was uncertainty about how household spending would respond to the erosion of real wages, as wages have not kept pace with consumer prices. There is no contemporary experience as to how labour costs and prices in Australia would behave at an unemployment rate below 4 per cent. Members also considered how households would respond to rising interest rates, given the high level of household debt and the significant increases in financial buffers over the preceding couple of years. The Board will continue to monitor these and other issues closely as it determines the timing and extent of future interest rate increases.

Members considered three options for the size of the rate increase at the present meeting – raising the cash rate by 15 basis points, 25 basis points or 40 basis points. Members agreed that raising the cash rate by 15 basis points was not the preferred option given that policy was very stimulatory and that it was highly probable that further rate rises would be required. A 15 basis point increase would also be inconsistent with the historical practice of changing the cash rate in increments of at least 25 basis points. An argument for an increase of 40 basis points could be made given the upside risks to inflation and the current very low level of interest rates. However, members agreed that the preferred option was 25 basis points. A move of this size would help signal that the Board was now returning to normal operating procedures after the extraordinary period of the pandemic. Given that the Board meets monthly, it would have the opportunity to review the setting of interest rates again within a relatively short period of time, based on additional information.

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Cash RatesInterest ratesMonetary PolicyRBA