The Reserve Bank of Australia (RBA) recently issued a warning that there are significant risks in continuing the current trajectory of curbing inflation without tipping the nation into a recession. With its June board meeting minutes published, RBA board members responded to both the rising unemployment rates and the delicate path to returning to a more normal rate of inflation.
The board observed that, even though the unemployment rate is still low, consumer spending has weakened noticeably due to higher interest rates and high inflation affecting households’ buying power.
In his efforts to explain how the Reserve Bank of Australia (RBA) is attempting to temper the economy without causing a recession, Governor Philip Lowe has previously discussed the “narrow path” concept. Dr Lowe noted earlier this year that the RBA is facing two major risks in executing this plan through aggressive interest rate hikes.
“The risk of not doing enough to bring inflation down would result in it persisting and, as I said earlier, it would then be costly to bring down later on. Conversely, the risk of reacting too quickly or taking too drastic measures could cause the economy to slow down more than necessary to bring inflation down in a timely manner,” he said.
At the RBA’s most recent board meeting, the minutes show the bank strongly considered keeping the cash rate at 3.85 percent and only narrowly deciding to raise it again in June.
The RBA’s decision to raise the cash rate by a quarter of a percentage point to 4.10 per cent, the highest rate in 11 years, has been described by the board as a carefully weighed decision. Over the past year, the official cash rate has been increased 12 times since May, with hikes taking place at every meeting aside from April.
The minutes reflect the board had considered both a twenty-five basis point raise of the cash rate, and not changing the rate and potentially raising it at a later meeting; however, they ultimately decided that another interest rate hike was their preferred option, as they felt it would help ensure that inflation would return to a normal level within a reasonable time period.
Board members observed that the inflation rate, which is currently at 7%, has surpassed its peak, yet remains much higher than the preferred range of 2 to 3% set out by the bank, and is anticipated to reach the upper end of this range not earlier than mid-2025.
The RBA board stated that although both the bank and government expected a gradual decrease in inflation during the June quarter, they were still concerned about the possible inflationary repercussions of wages growth when explaining their choice to increase the cash rate to 4.10 percent.
At the discussion, the members considered if past high inflation would have a sweeping effect of implicit indexation of wages. It was further noted that some businesses had already set their prices based on past inflation either explicitly or implicitly. This raised the possibility that high inflation could become a long-term issue, complicating the task of keeping the economy under control.
At the RBA meeting, the board deliberated whether to retain the cash rate due to the apprehension that the latest considerable hikes in interest rates could cause a greater economic slowing than predicted, just after the Fair Work Commission’s 2023 annual wage audit declared a 5.75 hike in the minimum wage.
