As widely expected, the RBA has increased the cash rate again by 0.5% taking it to 1.85%. This is more than double the 0.75% rate that applied before the pandemic started. The 175 basis points in rate hikes since April is the fastest back-to-back series of rate hikes since increases of 0.25%, 0.75% and 1% in October, November and December 1994 respectively.

In justifying another 0.5% hike the RBA noted that: inflation is the highest its been since the early 1990s and set to rise further with strong demand and a tight labour market playing a role; the labour market remains tight and businesses are pointing to a lift in wages growth; and it is important that medium term inflation expectations remain “well anchored”. While the RBA downgraded its growth forecasts to 3.25% for this year and to 1.75% for the subsequent two years it revised up its inflation forecast for this year from 6% to 7.75% and to 4% in 2023.

The RBA’s rapid rate hikes reflect a desire to bring demand back into line with constrained supply and to contain inflation expectations by reinforcing its commitment to its inflation target. Containing inflation expectations is critical as the 1960s and 1970s experience tells us the longer high inflation persists the more inflation expectations will rise and get built into price and wage setting making it even harder to get inflation back down…