By Stella Qiu and Wayne Cole
SYDNEY, March 17 (Reuters) – Australia’s central bank raised rates for a second straight month in a tight call on Tuesday, warning of a “material” risk to inflation as policymakers stepped into a volatile global backdrop amid an intensifying Middle East war.
The Reserve Bank of Australia kicked off a critical week for major central banks as the U.S.-Israeli strikes on Iran unleash an oil shock.The Federal Reserve and the European Central Bank are widely expected to keep interest rates unchanged, though the war threatens to throw their future calculus off course.
Wrapping up the March policy meeting, the RBA raised its main cash rate by 25 basis points to 4.1%, a 10-month high and undoing two of the three cuts it made last year, cautioning that risks to inflation have tilted further to the upside.
Markets had wagered on a 75% probability of a hike after senior RBA officials flagged the meeting as “live,” with inflation stuck above the 2%-3% target band and the labour market still running hot. All “Big Four” Australian banks tipped a rise.
“The domestic data flow alone justified a rate hike today,” said Belinda Allen, head of Australian economics at the Commonwealth Bank of Australia.
“But new complications have arisen adding to the inflation challenge… Excess demand needs to slow to bring inflation back to target and protect against second order impacts from higher inflation (from the Iran war).”
It was the central bank’s most tightly contested vote since it began disclosing tallies last year, with the board split 5-4 in favour of the hike.
Governor Michele Bullock, in her post-policy press conference, said the split reflected timing rather than direction, stressing that all board members agreed further tightening was necessary.
“We had a very robust conversation over the past two days about whether we should hold until May” to allow for more data and clarity on the Middle East conflict, Bullock said.
“The board decided raising the cash rate was the right call… If we do not act, these price pressures will spread and the eventual adjustment will be harder.”
The Australian dollar bounced 0.2% to $0.7088 after Bullock laid out the reasoning behind the close call. Three-year government bond futures pared earlier losses to be off just 2 ticks at 95.41.
Markets wagered on a 40% probability that the RBA could deliver another rate hike in May, with a move by August to 4.35% fully priced in.
RATE CUTS BEING UNDONE
The RBA took a gentler path than its global peers during the inflation surge, prioritising hard-won gains in the labour market over rapid tightening. Interest rates peaked at 4.35% early last year before three cuts brought them down to 3.6%.
However, that approach saw inflation rear its head again from the second half of the year, forcing the RBA to raise rates again last month. Headline CPI ran at 3.8% in January and the core measure hit a 16-month high of 3.4%, going in the wrong direction.
The labour market also remained tight, with the jobless rate holding at a historic low of 4.1%. The economy grew 2.6% from a year earlier in the December quarter, the fastest annual pace in almost three years and way above the RBA’s 2% estimate of potential.
With no end in sight to the Middle East conflict and oil holding above $100 a barrel, inflation risks are firmly skewed to the upside. The RBA’s latest February forecasts already pencilled in headline inflation reaching 4.2% by mid-year before the war unleashed a fresh global oil shock.
Consumer confidence took a hit, with a survey from ANZ on Tuesday showing sentiment last week was at the lowest level since early 2020 when the first pandemic lockdowns were announced.
“With the board already split, a follow-up hike in May looks less certain,” said Luci Ellis, chief economist at Westpac, although she is sticking to her call of a May move following Bullock’s explanation for the split vote.
“Whether the conflict in the Middle East is still ongoing and how it evolves from here will be crucial.”
(Reporting by Stella QiuEditing by Shri Navaratnam)
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