Australia central bank stuns with 25-bps hike, warns more might be needed

Australia's central bank on Tuesday stunned markets by raising its cash rate 25 basis points when traders had looked for an extended pause, saying inflation was way too high and warned that even further tightening may be needed to bring it to heel.

The unambiguously hawkish policy stance sent the Australian dollar soaring and bond futures tumbling as markets quickly lifted the peak for interest rates.

 

Wrapping up its May policy meeting, the Reserve Bank of Australia (RBA) raised rates to 3.85 percent and said "some further tightening" may be required to ensure that inflation returns to target in a "reasonable timeframe".

Markets, as well as a majority of analysts, had been wagering heavily on a steady outcome given core inflation had eased a little more than expected and the full pain of the RBA's past tightening was yet to be felt in the economy.

The Australian dollar shot up by 1 percent to $0.6695, while three-year futures dived 23 ticks to 96.780, the sharpest daily drop since mid-2012.

 

Futures slid as the market priced in the new 3.85 percent rate and implied around a 60 percent chance rates could reach 4.10 percent by August.

 

"Inflation in Australia has passed its peak, but at 7 percent is still too high and it will be some time yet before it is back in the target range," said governor Philip Lowe.

"Given the importance of returning inflation to target within a reasonable timeframe, the Board judged that a further increase in interest rates was warranted today."

The much-watched first quarter consumer prices data last week confirmed that inflation was easing from 33-year highs. However, even after taking into account Tuesday's hike, it is only projected to return to 3 percent - the top of the RBA's target band of 2-3 percent - in mid-2025, according to the central bank's latest forecasts.

Inflation is now expected to slow to 4.5 percent this year, compared with the previous forecast of 4.75 percent.

 

"This is an awfully long time for inflation to exceed target, and runs the risk that higher inflation expectations will become embedded," said Sean Langcake, Head of Macroeconomic Forecasting for BIS Oxford Economics.

"This would ultimately lead to even higher interest rates, which the Bank is looking to avoid as it seeks to keep some momentum in the economy".

INFLATION STILL PROBLEMATIC

 

Supermarket chain Woolworths(WOW.AX) is seeing signs of inflation moderating in food, although it remained "frustratingly elevated" in many areas, Chief Executive Officer Brad Banducci said in an earnings call on Tuesday.

A surge in migration, which could lift population growth to a heady 2.0 percent this year, is fueling increases in rents and adding to inflationary pressures in the short-term.

Also on Tuesday, the RBA lowered the economic growth forecast for this year to 1.25 percent, compared with 1.5 percent previously, while projecting the unemployment rate to increase to around 4.5 percent in mid-2025.

The labor market remained tight, with net employment blowing past expectations in March and the jobless rate hovering at near 50-year lows.

Home prices are also showing signs of bottoming out, having risen for the second straight month in April, supported by rising migration levels and a chronic shortage in housing supply.

Governor Lowe will speak tonight at 0920 local time (2320 GMT) to explain the Board's thinking behind the surprise hike and answer questions from the audience.