If inflation has peaked, why does the RBA keep raising interest rates?

When will the RBA stop inflicting pain on the economy?

A man sits in deep thought with a pen held to his lips as he ponders his computer screen with a laptop open next to him on his desk in a home office environment.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Key points

  • The RBA just increased the interest rate by 0.25% to 3.35%
  • It’s expecting more increases in 2023 to tame inflation
  • The board wants to keep a lid on cost inflation and stop a wage growth spiral

The Reserve Bank of Australia (RBA) just increased the interest rate again despite inflation supposedly peaking. What's going on and how much more pain will be inflicted on mortgage holders and the S&P/ASX 200 Index (ASX: XJO)?

Yesterday, Australia's cash rate was increased by another 25 basis points, or 0.25%, to 3.35%. Remember that less than a year ago the interest rate was just 0.10%.

The main goal of central banks is to reduce inflation back down to its target range by taking some demand out of the economy. For the RBA, that target range is between 2% to 3% while keeping the economy on an even keel.

Inflation peaks in Australia?

As noted by the RBA, CPI inflation over the 12 months to 31 December 2022 was 7.8%, the highest since 1990.

In underlying terms, inflation was 6.9%. This was higher than expected and may be one of the key reasons why the RBA was concerned enough to announce that 2023 would see more rate rises.

The RBA believes that "global factors explain much of this high inflation, but strong domestic demand is adding to the inflationary pressures in a number of areas of the economy."

Employment remains very strong. The RBA called the labour market "very tight" with the unemployment rate "steady at around 3.5%", which is the lowest rate since 1974. Job vacancies and job ads are both at "very high levels", but have declined a little recently, with some businesses reporting a recent easing in labour shortages.

It noted that as economic growth slows, unemployment is expected to increase to 3.75% by the end of 2023.

Why are interest rates still going up?

The key factor seems to be that the RBA wants to do everything it can to avoid strong inflation. RBA boss Dr Lowe isn't focused on what's happening with ASX 200 shares. In the statement, the board said:

The board's priority is to return inflation to target. High inflation makes life difficult for people and damages the functioning of the economy. And if high inflation were to become entrenched in people's expectations, it would be very costly to reduce later.

While some cost inflation may have peaked, the RBA is keeping a close eye on wage growth, which is "continuing to pick up from the low rates of recent years and a further increase is expected due to the tight labour market." The RBA then said:

Given the importance of avoiding a prices-wages spiral, the board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead.

Despite the 0.25% increase, the RBA "expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target and that this period of high inflation is only temporary."

Plenty of economists thought the RBA would only do two further increases – yesterday's and one more, taking the rate to 3.6%. But, with the way the central bank's outlook was worded, could the rate reach 3.85%? Or even 4%?

It's possible the RBA may only go to 3.75%, but it seems interest rates are going to lift by more than most people were expecting.

The ASX 200 may be resilient as a whole in the face of these hikes. The US Federal Reserve seems to be slowing its rate increases, the ASX bank shares could benefit from higher rates, and the miners are benefitting from higher commodity prices. It's no mistake that the Commonwealth Bank of Australia (ASX: CBA) share price is close to $110 and its all-time high.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Share Market News

A young woman sits at her desk in deep contemplation with her hand to her chin while seriously considering information she is reading on her laptop
Opinions

1 ASX 200 dividend stock down 20% to buy right now

This beaten-up ASX share could be a top pick for dividends and stability.

Read more »

Man sitting in a plane looking through a window and working on a laptop.
Opinions

2 cheap ASX 200 shares I'd buy in May

I think these stocks are too cheap to ignore.

Read more »

Smiling couple looking at a phone at a bargain opportunity.
Share Gainers

Why Gentrack, New Hope, Nuix, and Star Entertainment shares are charging higher

These shares are starting the week strongly. But why?

Read more »

A man sits in despair at his computer with his hands either side of his head, staring into the screen with a pained and anguished look on his face, in a home office setting.
Share Fallers

Why Core Lithium, Duratec, Galan Lithium, and Michael Hill shares are sinking today

These shares are starting the week in the red. But why?

Read more »

A trio of ASX shares analysts huddle together in an office with computer screens all around them showing share price movements
Broker Notes

Why brokers just revised their outlook for these 4 top ASX All Ords shares

These four ASX All Ords companies were just re-rated by top brokers.

Read more »

Invest written on a notepad with Australian dollar notes and piggybank.
Opinions

I'd invest $10,000 into these excellent ASX shares for the long term

I’m bullish about these top stocks.

Read more »

A man slumps crankily over his morning coffee as it pours with rain outside.
Materials Shares

Why did this ASX All Ords stock just crash 24%?

What is weighing down this lithium stock today? Let's find out.

Read more »

Young woman using computer laptop with hand on chin thinking about question, pensive expression.
Opinions

Should you buy Telstra stock on a pullback?

Is this telco a buy for value hunters?

Read more »