Hunter: Cash rate raised to 4.35 percent on inflation risks
RBA Assistant Governor Sarah Hunter announced the cash rate increase to 4.35 percent, citing elevated capacity constraints and inflation expectations. Speaking at the Bloomberg Forum, she detailed the RBA's framework for assessing the Middle East conflict's impact on inflation.
Conflict Shapes Inflation Outlook
Assistant Governor Hunter detailed how the Middle East conflict is shaping Australia's inflation outlook, which was already above target due to domestic cost pressures.
The conflict acts as a clear external shock, directly increasing Australian petrol prices, which peaked at a 36 percent rise.
Indirectly, higher fuel costs impact production and transport across various sectors and global supply chains.
The RBA's May forecasts now project headline inflation to peak at 4.8 percent in the June quarter, significantly higher than previous expectations.
Underlying inflation has also been revised higher in the near term.
The baseline forecast assumes a swift resolution to the conflict, easing domestic capacity pressures, and the impact of higher cash rates, supporting a decline in inflation to the target band by early 2028.
However, significant uncertainties remain, including the persistence of elevated oil prices and stronger-than-assumed cost pass-through.
Anchoring Expectations, Managing Pass-Through
Assistant Governor Hunter outlined the RBA's framework for price stability, targeting 2-3 percent average CPI growth.
The framework identifies domestic cost pressures, like spare capacity, and external costs, such as import prices, as key drivers.
A crucial element is how quickly firms pass through cost shocks to consumer prices.
RBA research indicates that when capacity is constrained and inflation is already elevated, this pass-through is faster and more extensive.
Unanchored inflation expectations pose a significant risk, potentially leading to larger second-round effects and necessitating a more substantial economic slowdown to restore price stability.
Anchoring expectations around the inflation target is therefore paramount for the central bank.
A Challenging Balancing Act
The recent oil price surge presented a difficult challenge for the Monetary Policy Board, coming against a backdrop of elevated capacity constraints.
Given the heightened risk of faster pass-through and embedded inflation expectations, the decision to raise the cash rate was a necessary pre-emptive measure.
This aims to anchor expectations and ensure inflation returns to target, albeit with ongoing uncertainties in the outlook.