RBA Minutes: June Monetary Policy

Selected excerpts below:

International economic developments

Measures of underlying inflation remained high in most advanced economies and had not yet shown signs of easing. Persistent supply chain disruptions, tightening labour market conditions and the ongoing recovery in private demand were contributing to strong underlying inflationary pressures. Members noted that the sources of inflation were broadening. Services inflation, which is typically more persistent than goods inflation, had picked up noticeably in advanced economies over the preceding year to be well above pre-pandemic levels.

Domestic economic developments

Members agreed that inflation in Australia had increased significantly owing to both global and domestic factors; it had also become more broadly based. Domestically, capacity constraints in some sectors and the tightening in labour market conditions had contributed to this. Higher prices for electricity and gas and recent increases in petrol prices meant that inflation was likely to peak at a higher level than expected a month earlier. More broadly, information from the Bank’s liaison program indicated that upstream price pressures were being passed on by firms, as global and domestic supply chain pressures had persisted and demand had remained strong. Indeed, the domestic demand deflator, which is the broadest measure of domestic prices in the national accounts, had increased at its fastest rate in more than two decades in the March quarter. Measures of long-term inflation expectations remained in the 2 to 3 per cent target band, although members noted there was a risk that a sustained period of higher inflation could result in a shift up in expectations of inflation. A particular source of uncertainty related to future wage outcomes during a period of high inflation and tight labour market conditions.

Review of the yield target

Members noted that the yield target, along with the three-year Term Funding Facility, could be construed as a form of time-based forward guidance, implying that the Board’s decisions were dependent on the calendar, when in fact they depended on the state of the economy. They agreed to undertake a review of the Bank’s general approach to forward guidance later in 2022.

Considerations for monetary policy

In considering the policy decision, members observed that inflation in Australia had increased significantly and that the outlook for inflation had been revised higher over the prior month. Inflation was expected to increase further, before declining back towards the top of the 2 to 3 per cent range in 2023.

Two options for the size of the cash rate increase were considered: raising the cash rate target by 25 basis points or by 50 basis points. Members noted that both options would leave the cash rate below 1 per cent, which would still be highly stimulatory, and that further increases would be required.

The main argument for an increase of 50 basis points was that the level of interest rates was still very low for an economy with a tight labour market and facing a period of higher inflation. Additionally, the inflation mindset in Australia appeared to be shifting. Firms had become more willing to pass on cost increases to consumers and, in a tight labour market, employees were demanding higher wages as compensation for higher living costs. In such an environment, there is a heightened risk of persistently high inflation, especially if expectations of higher inflation become entrenched. If that were to occur, the task of returning inflation to the target would become more difficult and come at a higher cost in terms of lower levels of economic activity and employment. Raising the cash rate by 50 basis points at the current meeting would help to mitigate this risk.

The argument for an increase of 25 basis points was that a sequence of 25 basis point moves represented a steady approach to withdrawing monetary policy stimulus and that this was appropriate in an uncertain environment. Members observed that if the cash rate were to be increased by 25 basis points at each meeting over the remainder of 2022, the cash rate would be 2.1 per cent by the end of the year. In a historical context, this would be quite a rapid tightening. While some central banks had been increasing policy rates in 50 basis points increments, these central banks meet less frequently than the Reserve Bank Board. Members also noted that, over the preceding couple of decades, increases in the cash rate had typically occurred in 25 basis point increments. The previous instance of the Board having increased the cash rate by 50 basis points was in February 2000.

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Monetary PolicyRBA