RBA says inflation is due to supply issues: so why are rates still going up?

With the Reserve Bank of Australia (RBA) having hiked the national cash rate by 50 basis points in back to back months, and with more hikes likely to come in the future, Australian mortgage holders are under increasing financial pressure. But what effect are these rate rises expected to have on high inflation, especially when several of the factors driving it upwards are coming from overseas?

In summary, while higher inflation is being spurred in part by supply issues, the RBA is still hiking rates to help "establish a more sustainable balance" between the demand for and the supply of goods and services.

Why did the RBA raise the cash rate? 

The main reason given for the recent rate rises has been to tackle high and rising inflation, which is expected to peak at around 7 per cent by the end of 2022 before declining in the following year.

In a statement released alongside the cash rate decision, RBA governor, Dr Philip Lowe, said that “the Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”

What’s causing inflation?

Governor Lowe’s statement acknowledges that several of the factors driving up inflation come from overseas, including COVID-related disruptions to supply chains, and the war in Ukraine affecting prices for energy and agricultural commodities.

Closer to home, Governor Lowe said that “strong demand, a tight labour market and capacity constraints in some sectors” were putting upward pressure on prices, along with recent flooding events.  

But since raising interest rates won’t cure a virus, stop a war, or reverse climate change, why did the RBA choose to raise the cash rate, which can drive up variable interest rates on Australia’s home loans?

How will raising rates help curb inflation? 

According to Governor Lowe’s statement:

“As global supply-side problems continue to ease and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Higher interest rates will also help establish a more sustainable balance between the demand for and the supply of goods and services. Medium-term inflation expectations remain well anchored and it is important that this remains the case.”

Governor Lowe added that the Australian economy remains resilient, and that with the unemployment rate steady at 3.9 per cent in May (the lowest rate in almost 50 years), the labour market is tighter than it has been for some time.

“Underemployment has also fallen significantly. Job vacancies and job ads are both at very high levels and a further decline in unemployment and underemployment is expected over the months ahead. The Bank's business liaison program and business surveys continue to point to a lift in wages growth from the low rates of recent years as firms compete for staff in the tight labour market.”

With this economic resilience in mind, Governor Lowe said that the recent interest rate increase was “a further step in the withdrawal of the extraordinary monetary support that was put in place to help insure the Australian economy against the worst possible effects of the pandemic.”

What will the RBA do next?

Future decisions around hiking Australia’s cash rate are to be made by the RBA Board in the months ahead, with the size and timing of any future increases to be based on both new economic data and the outlook for inflation and the labour market.

The Australian Bureau of Statistics (ABS) is scheduled to release the Consumer Price Index (CPI) data used to measure Australian inflation for the June 2022 quarter on 27 July 2022. The RBA is set to update their inflation forecasts sometime in August 2022 following the release of this inflation data, and to use these forecasts to help inform their future monetary policy decisions.

Governor Lowe also said that the Board will be paying close attention to various influences on household spending when assessing monetary policy, describing the behaviour of household spending as a “source of ongoing uncertainty about the economic outlook.”

“The recent spending data have been positive, although household budgets are under pressure from higher prices and higher interest rates. Housing prices have also declined in some markets over recent months after the large increases of recent years. The household saving rate remains higher than it was before the pandemic and many households have built up large financial buffers and are benefiting from stronger income growth.”

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