The S&P/ASX 200 Index (ASX: XJO) has taken a tumble this afternoon after the Reserve Bank of Australia (RBA) announced its first cash rate hike in years.
The benchmark index went from being broadly flat to down 0.5% within minutes of the RBA's announcement.
What was announced?
At its May meeting, the central bank elected to lift the cash rate by 25 basis points to 35 basis points.
The RBA has also increased the interest rate on Exchange Settlement balances from zero to 25 basis points.
According to the statement by Governor Philip Lowe, the RBA decided that now was the time to take action after inflation picked up more quickly than expected.
Mr Lowe also revealed that there is evidence of wage growth picking up, which combined with very low interest rates, made it appropriate to start the process of normalising monetary conditions. He explained:
"The Board judged that now was the right time to begin withdrawing some of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic. The economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than was expected. There is also evidence that wages growth is picking up. Given this, and the very low level of interest rates, it is appropriate to start the process of normalising monetary conditions."
What about future hikes?
Although the Reserve Bank expects inflation to eventually fall back to target levels once supply chain issues are resolved, it does expect higher inflation to remain in the short term.
In light of this, Governor Lowe has warned that it is likely to make further cash rate hikes. He said:
"The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead. The Board will continue to closely monitor the incoming information and evolving balance of risks as it determines the timing and extent of future interest rate increases."
In addition, the central bank believes that some withdrawal of the extraordinary monetary support provided through the pandemic is appropriate. This will see the bank no longer reinvesting the proceeds of maturing government bonds.
Though, Mr Lowe confirmed that it is not currently planning to sell the government bonds that the bank purchased during the pandemic.
