The Reserve Bank of Australia (RBA) has decided to stick with its 0.1% cash rate target for the time being, but hinted that it might rise earlier than the 2024 target.

The central bank confirmed what the market has been speculating on, that it will let market forces play out and not defend its cash rate target.

RBA Governor Philip Lowe defended the decision, saying the recent rise in yields seen in the market reflects the earlier-than-expected progress we’re seeing in the economy.

“Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished,” he said in a statement.

The three-year yield has been in focus because that’s where the RBA has maintained a yield curve control (YCC) program to effectively ‘cap’ the yield near the benchmark cash rate of 0.1%.

However, the bond market has priced in a rate rise by the middle of next year, driving the April 2024 (3-year) government bond yields to as high as 0.6%,  six times the RBA’s cash target.

The RBA statement today seems to have delighted the equity markets, with the ASX 200 jumping half a percentage point shortly after the release, but the AUD/USD dipped slightly by around 20 pips to US$0.7505.

 

Inflation to dictate rates move

Dr. Lowe says that he’s reluctant to alter his monetary stance until he sees inflation “sustainably” between the 2 and 3 per cent range.

The latest core CPI released last week showed that inflation jumped to 2.1%, topping forecast of 1.8% and pushing it just above the bottom of the RBA target range.

For inflation to sustain itself in the 2-3% range however, it will require the jobs market to be tight enough to generate wages growth that is materially higher than it is currently, Lowe said.

“This is likely to take some time,” he argued.

“The Board is prepared to be patient, with the central forecast being for underlying inflation to be no higher than 2.5% per cent at the end of 2023 and for only a gradual increase in wages growth.”

Some economists disagree with that forecast, with NAB for example predicting core inflation to rise to 2.6% by mid 2022, much earlier than what the RBA says.

 

What does this mean for Australians?

For most Australians, RBA interest rate decisions will dictate how cheap or expensive their home loans will become.

Our house prices are currently rising at the fastest pace since 1989, having increased by almost 20% just in the last 12 months.

CoreLogic’s research director, Tim Lawless, said that downside risks for the housing sector are rising.

“Along with worsening affordability and higher supply, there is the potential for a further tightening in credit policy and, off the back of strong inflation readings, the possibility of an early rate hike is looking increasingly likely,” he said.

But speculations that the RBA might hike rates to cool down the property market were quashed today, at least for the time being.

Although it’s unclear when the RBA will lift rates, one thing is certain: the next move will be up.