MNI RBA WATCH: Bullock Says Policy Too Loose, Hikes 25BP

Supply and demand are slightly out of balance and monetary policy is likely a bit loose, driving inflation over the past two quarters, Reserve Bank of Australia Governor Michele Bullock said on Tuesday after a unanimous decision to raise the cash rate by 25 basis points to 3.85%.

The Board will remain focused on incoming data, monitoring developments and updating its forecasts, Bullock said, following the largely-anticipated decision to make the first hike since 2023, returning the cash rate to its level prior to the August 2025 cut. (See MNI RBA WATCH: Board Eyes 25bp Cash Rate Hike)

While she refrained from explicit guidance as to whether the move marked the start of a renewed tightening cycle, Bullock said the Board was uncomfortable with updated forecasts showing higher inflation persisting through 2028, based on a market-implied cash rate path peaking at 4.3% in 2027. “Our forecasts aren't suggesting that [inflation] is shooting off, but if it stays persistently at that level, that is not acceptable, and that is what the board has decided today, and that is why they have raised interest rates now.”

Markets interpreted the remarks as a hawkish turn, swiftly pushing the Australian dollar up by about 1% against the U.S. dollar to 0.702. Overnight index swaps firmed by around 3-7 basis points across the curve, with markets pricing a 4.154% cash rate by December.

But Bullock stressed the current situation differed from the post-pandemic tightening cycle, when rates were lifted rapidly from emergency lows. “This isn't as clear as earlier. We are in a position where we think we might be around neutral in terms of financial conditions … Now we think maybe there's a bit of excess demand," Bullock continued, noting the board would actively monitor data to gauge policy settings. 

HAWKISH FORECASTS

The RBA’s updated Statement on Monetary Policy showed weaker outcomes across most indicators despite the higher assumed cash rate.

Headline inflation is forecast to rise to 4.2% by June, up from the expectation for 3.7% in November’s projections, before easing below 3% by June 2027 to 2.9%, 20bp higher than the previous forecast. The unemployment rate is expected to increase to 4.5% by December 2027 and to 4.6% in 2028, while the Bank lowered its labour productivity growth forecast by 30bp to 0.6% over the next 18 months and cut its GDP growth outlook by 30bp to 1.6% by June 2027.

While some have placed hope in AI to lift productivity, Bullock said it was not the RBA’s role to speculate on specific sources of growth. "The only point I'm making is that the economy can't grow more quickly than the potential, and if we think potential growth is around about 2% then the minute the private demand starts to pick up above that, then it potentially poses challenges for inflation."

FINANCIAL CONDITIONS

Bullock said the Board broadly agreed that financial conditions were slightly loose at the margin, citing strong credit growth, a rebound in housing activity and ample availability of financing for households and businesses.

The Board does not have a pre-set path for rates and Bullock cautioned against reading the market-implied cash rate path used in forecasts as guidance. While faster rate increases could bring inflation down more quickly, such an approach could carry significant costs for employment and growth, she reiterated, noting the Bank's so called "narrow path" strategy had not changed. "We are still trying to bring inflation down and keep employment as strong as we can, as close to sustainable for employment as we can.”