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The Reserve Bank board went to the brink of leaving official interest rates on hold a fortnight ago because of rising household pressures, but opted for another hike on fears that inflation could become entrenched.
Key points:
- The RBA board is concerned about recent increases in property prices
- It thinks the unemployment rate needs to rise to 4.5 per cent
- But it wants people to believe that inflation is coming down
It also wants Australia's unemployment rate to rise from 3.6 per cent to roughly 4.5 per cent, and says higher interest rates will help to achieve that.
Michelle Bullock, RBA deputy governor, says many workers have benefited from these historically-tight labour markets, but this high level of employment is probably too high and is contributing to inflation.
In a speech on Tuesday, she said the RBA's "goal" was to return the labour market to a better balance between supply and demand for labour, and this would be achieved by slowing the pace of employment and economic activity for a while, with higher rates.
In the minutes from its June 6 meeting - also released on Tuesday - where the cash rate was taken to 4.1 per cent, the RBA board assessed "finely balanced" arguments, given the risk that sustained inflation would lead to even higher interest rates in the future.
Deciding on the 12th rate hike since May last year, the RBA board concluded that if inflation was not confronted, more aggressive rate-hiking action could lead to a sharp rise in unemployment.
RBA members noted that a prolonged period of above-target inflation would add to inflation psychology in which firms and households factored rising inflation into their budgets.
"If this occurred, high inflation would become persistent with the result that interest rates would need to be higher for even longer. This would increase the risk of a sharp rise in unemployment," the minutes warn.
"An extended period of high inflation would distort the economy and exacerbate cost-of-living pressures, hurting those on low incomes the most."
Minutes show it was a lineball call
The minutes show the RBA board was also concerned about recently rebounding real estate prices, implying less of a drag on consumer spending over the next year.
The alternative argument of holding the cash rate at 3.85 per cent was based on evidence the economy was rapidly slowing and the possibility more interest rate rises would lead to a sharper-than-expected deterioration.
The board also considered the impact of fixed-rate mortgages expiring in the coming months, which would see financial conditions tighten even more and unemployment rising more than expected.
However in opting to raise the cash rate , the RBA board noted the household pain being felt from rising interest rates.
"Members acknowledge the considerable uncertainty … for household spending and the financial stresses facing some households," the minutes say.
The board agreed to monitor the implications and developments for the global economy but reaffirmed its determination to bring inflation back to the 2 to 3 per cent target band.
The board also considered the decision by the Fair Work Commission to increase award wages by 5.75 per cent.
While saying it was "understandable" that lowest-paid workers should be compensated for high inflation, the board warned against a wider wages breakout.
"It would be concerning if wages across a broad range of jobs were to become implicitly indexed to high inflation," the minutes said.
Since the June 6 decision, stronger-than-expected labour force data is raising rate-rise expectations, after the May jobless rate fell to 3.6 per cent with 75,900 new jobs created.
Money markets are now factoring in a 90 per cent chance of another rate rise at the RBA's meeting on July 4 taking the cash rate to 4.35 per cent.
More to come..