Australia raises rates for first time in two years

[SYDNEY] Australia’s central bank on Tuesday raised its benchmark policy rate for the first time in two years, saying the economy was growing faster than expected and inflation was likely to remain above target for some time.

The Reserve Bank of Australia now joins the Bank of Japan as the only other developed-world central bank tightening policy at the moment. Markets are still priced for rate cuts in the US, UK and Canada, while the European Central Bank is widely expected to be on an extended pause.

Wrapping up the February policy meeting, the RBA raised interest rates by 25 basis points to 3.85 per cent in a unanimous decision, delivering the first hike in two years, and coming just six months after its last cut in August.

“With the RBA now expecting a slower moderation in inflation (despite a higher rate path), the risk is clearly skewed toward a series of hikes rather than a one-off move – particularly in light of today’s unanimous decision,” said Harry Murphy Cruise, head of economic research for Oxford Economics Australia.

Markets had wagered on a 78 per cent probability of a hike on Tuesday given inflation surprised on the high side in the fourth quarter, while unemployment hit a seven-month low in December.

“While part of the pick-up in inflation is assessed to reflect temporary factors, it is evident that private demand is growing more quickly than expected, capacity pressures are greater than previously assessed and labour market conditions are a little tight,” the RBA’s board said in its policy statement.

“The board judged that inflation is likely to remain above target for some time and it was appropriate to increase the cash rate target.”

The Australian dollar extended earlier gains to be up nearly 1.2 per cent to US$0.7027 while three-year government bond futures tumbled 10 ticks to 95.64.

Investors ramped up bets for a follow-up hike in May, which is now priced at nearly 80 per cent. Markets expect an additional total tightening of 40 basis points this year.

SEE ALSO

Australia set for U-turn to rate hike in break from global trend

Australia’s home-price gains accelerate even as rate hike looms

Australia committed to retaking ownership of Darwin port, Albanese says

Inflation surprise set to keep RBA on toes

The RBA did not raise interest rates as aggressively as its international peers when inflation was running hot due to its desire to preserve gains in the labour market.

That approach may yet test policymakers. The central bank’s three rate cuts last year saw inflation rear its head again, forcing it to pivot towards a hawkish stance late in 2025 and prompting market bets of an earlier-than-expected start to the tightening cycle.

Consumer price growth has surprised on the upside for two straight quarters now, and is well above the RBA’s target band of 2 per cent to 3 per cent. Underlying inflation, the central bank’s preferred measure, ran at a quarterly pace of 0.9 per cent in the fourth quarter, lifting the annual pace to the highest in over a year at 3.4 per cent.

The recent flow of data has only served to reinforce the need for a quicker-than-expected turn in monetary policy levers, with a surprise fall in the unemployment rate to a seven-month low of 4.1 per cent suggesting the labour market may have started to tighten again.

Robust consumer spending, record-high housing prices and easy credit availability for households and businesses added to the case that financial conditions might not be restrictive at all.

In a separate economic update, the RBA said it was uncertain that financial conditions were restrictive and some indicators suggested they may have been accommodative.

It saw the risk of persistently high inflation even on the technical assumption of more than two rate hikes this year.

“Overall, it’s clear that the RBA believes the road to disinflation will be a long and winding one,” said Abhijit Surya, senior APAC economist at Capital Economics.

Surya expects only one more hike in May, but said since the “bank doesn’t expect underlying inflation to return to the mid-point of its 2-3 per cent target even by early-2028, it’s entirely possible that it will feel compelled to raise rates even higher.” REUTERS