RBA Leaves Cash Rate Unchanged at 4.35 Percent Amid High Inflation and Uncertain Outlook

RBA Leaves Cash Rate Unchanged at 4.35 Percent

The Reserve Bank of Australia (RBA) has decided to maintain the cash rate target at 4.35 percent, along with the interest rate paid on Exchange Settlement balances at 4.25 percent. This decision comes after the RBA’s board meeting on Tuesday. The RBA’s media statement released on Tuesday afternoon stated that while inflation remains high, it is declining at a slower rate than expected. The Consumer Price Index (CPI) grew by 3.6 percent in the year leading up to the March quarter, down from 4.1 percent in the previous year.

The RBA highlighted that underlying inflation, which excludes volatile factors, was higher than headline inflation and declining at a slower pace. This was mainly due to services inflation, which remains high and is only gradually moderating. Despite higher interest rates working towards balancing aggregate demand and supply, there are still indications of excess demand in the economy, coupled with strong domestic cost pressures for both labor and non-labor inputs.

Uncertain Economic Outlook and Inflation Target

The RBA acknowledges that the economic outlook remains highly uncertain. Recent data suggests that the process of returning inflation to target will not be smooth. Based on current market expectations, the RBA forecasts inflation to return to the target range of 2 to 3 percent in the second half of 2025 and reach the midpoint by 2026. However, near-term inflation is expected to be higher due to the rise in domestic petrol prices and slower-than-expected decline in services price inflation throughout the rest of the year. The persistence of services inflation remains a key uncertainty.

Impact on Household Consumption and Monetary Policy

The RBA notes that household consumption growth has been weak, primarily due to high inflation and previous interest rate hikes affecting real disposable income. Consequently, households have been cutting back on discretionary spending and increasing their savings. Additionally, there are uncertainties surrounding the impact of monetary policy on firms’ pricing decisions, wages, and the overall growth of the economy in the face of excess demand and a tight labor market. Furthermore, there is a high level of uncertainty regarding the international outlook, given persistent geopolitical uncertainties.

Returning inflation to the target range remains the RBA’s top priority. The board emphasizes the importance of medium-term inflation expectations aligning with the inflation target. While inflation is easing, it is doing so at a slower rate than anticipated and remains high. The board anticipates that it will take some time before inflation is sustainably within the target range. As a result, the RBA will remain vigilant to upside risks and will rely on data and evolving risk assessments to determine the path of interest rates that will ensure inflation returns to target within a reasonable timeframe.

Expert Insights and Concerns

CreditorWatch chief economist Anneke Thompson believes that while goods inflation is approaching a comfortable level, services inflation is proving more challenging to lower. In the March quarter, services inflation decreased by just 0.3 percent. However, Thompson points out that the cash rate has a limited impact on services inflation compared to goods inflation. She highlights that businesses in discretionary retail, food, and drink sectors may face difficulties due to tight fiscal policies, leading consumers to tighten their purse strings.

Thompson refers to CreditorWatch’s March 2024 Business Risk Index (BRI), which reveals that a significant percentage of invoices issued in the food and beverage services and retail trade sectors are now more than 60 days overdue. Thompson suggests that upcoming employment figures will heavily influence future cash rate decisions by the RBA. Proponents for further tightening of monetary policy argue that sticky services inflation warrants an increase in the cash rate. On the other hand, those against tightening highlight falling goods inflation and stagnant retail sales as evidence that monetary policy is already tight enough.

Thompson warns that any softening of the employment market could mark the peak of the tightening cycle. Given the high cost of debt, many households and small businesses find themselves in precarious financial positions. Therefore, the RBA needs to consider these factors while making future monetary policy decisions.

Overall, the RBA’s decision to maintain the cash rate reflects the ongoing uncertainties in inflation and the economic outlook. While inflation is gradually declining, services inflation remains a concern. The RBA will continue to closely monitor data and assess risks to ensure inflation returns to its target range in a reasonable timeframe.