The Reserve Bank of Australia (RBA) has warned that further interest rate increases are still possible, with a former RBA governor arguing the low-rate era is over, leaving households feeling like Australia is heading for recession.
In minutes from its latest meeting, where it lifted the cash rate to 3.85 per cent, the RBA reiterated that the door remains open to future hikes.
"Further increases in interest rates may still be required, but that this would depend on how the economy and inflation evolve," the bank's board concluded.
However, the hurdle for further increases is likely to be high, given that May's decision was "finely balanced", with the RBA spending as much space outlining the case for keeping rates on hold as for the increase.
It seems the decision to lift rates was ultimately based on choosing a path of least regret, with the "upside risks" of inflation remaining too high outweighing those of an economic downturn sparked by hiking rates too far too fast.
The bank outlined the effect of a recent migration "influx" on rents, which were expected to add to inflation pressures for some time, while also noting strength in the jobs market, weak productivity growth and the rising rate of services inflation.
"If these risks materialised, they would further delay the return of inflation to target, with the prospect of a damaging shift in inflation expectations," the minutes recorded.
"Further, members noted that the forecasts presented at the meeting were predicated on a technical assumption for the path of the cash rate that involved one further increase."
If there was a final clincher for the rate increase this month, it was the property market's rapid and unexpected recovery, along with a fall in the Australian dollar.
"While several factors had contributed to these developments, the decision to hold interest rates steady in April was likely to have contributed," the minutes noted.
"Although the board does not target asset prices, members agreed that movements in asset prices provide relevant information and need to be considered when assessing the outlook for activity and inflation."
Rate rises a 'no brainer' says former RBA boss
Speaking as a keynote guest at the gas industry's annual conference, organised by the Australian Petroleum Production and Exploration Association (APPEA), former RBA governor Glenn Stevens said households and businesses should brace for interest rates to staying higher for longer.
Mr Stevens told the audience that he suspected the "economic era" of low inflation had ended.
"When I finished in central banking, nearly seven years ago now, inflation was too low and it was difficult to get it to go up," he observed.
"Who would have thought that we now be in a world where it's too high, and I think it will be difficult to get it to come down.
"I could be wrong but, if that is the case, then I think we've also transitioned from a world in which interest rates were low for long[er] … to one in which they will be elevated for some time.
"Not necessarily that much higher than now, but I think a return to the ultra-low rates that we saw for a while there is unlikely."
The man who ran the RBA for a decade between 2006 to 2016 said it was a "no-brainer" for central banks to move aggressively last year to try to stamp out inflation with steep rate rises.
"Central banks are in a once-in-a-generation battle to return inflation to the very low and stable levels that it was at, and that was such a strong foundation of the preceding several decades of prosperity," he said.
Mr Stevens also poured cold water on the prospects of getting inflation under control without a recession, in comments directed at the US, but similarly relevant to RBA governor Philip Lowe's statements about the "narrow path" Australia's economy faces.
"It's worth recalling that, since World War II, most significant falls in US inflation happened during or after a recession," Mr Stevens cautioned.
"The fabled soft landing is not entirely unknown, but it's not very common.
"And those outcomes tended to be associated with much more favourable developments on the supply side of economies than we see at the moment."
Small budget surplus 'the right thing to do'
After his prepared remarks, Mr Stevens was asked about the impact of the federal budget on the economy, after it had returned to surplus for the first time in 15 years.
The former RBA governor praised the return to a balanced budget, even though it is expected to be temporary.
"What the economy did for the budget was a large windfall gain in the bottom line because of strong growth, high commodity prices, and so on," he observed.
"I think it's to the government's credit that they've allowed most of that to flow through to the bottom line. That's the right thing to do."
The federal opposition and some economists have argued that billions of dollars in additional spending could fuel inflation and make the Reserve Bank's job harder.
But Mr Stevens said he does not think there will be much impact.
"I would assess … that the budget is slightly expansionary, but that would be my take," he said.
"Its implication for interest rates and inflation, I think, to be honest, not that much really.
"There's a dozen other things also affecting the economy, this is just one of them."
Rates, budget hit household sentiment
However, the budget's restraint appears to have added to household pessimism about their personal finances and the economy.
The widely watched Westpac-Melbourne Institute Consumer Sentiment Index dived 7.9 per cent this month, after rates were increased and the federal government delivered relatively modest cost-of-living relief in its budget last week.
"The index has fallen back to just above the dismal levels seen back in March, which recorded the lowest monthly read since the COVID outbreak in 2020 and, before that, since the deep recession of the early 1990s," noted Westpac's chief economist Bill Evans.
Confidence was weaker for those surveyed after the budget, the report noted, although this was quite normal.
"For 2023, 15.5 per cent of those surveyed after the budget expected it to improve their finances and 27 per cent expected to be worse off," Mr Evans explained.
"Viewed against history, the 2023 'gap' of 11.5 per cent is much less unfavourable than that of the previous budget in October (28 per cent) and is only bettered by one budget in the 2010-19 period."
However, the RBA's move to raise interest rates in May — when most analysts expected them to stay on hold, and some even tipped that the cash rate had peaked at 3.6 per cent — clearly shattered confidence.
"Nearly 70 per cent expect a further rise in variable mortgage rates over the next 12 months, with just over 40 per cent expecting them to rise by 1 percentage point or more," Mr Evans observed.
"Consumers are right to heed the RBA governor's explicit warning that 'some further tightening of monetary policy may be required' but the extent of these fears seems excessive."
However, it was not just borrowers who have become increasingly worried about their household finances, with renters — especially those on low incomes — feeling the strain.
"The sub-group detail shows bigger sentiment declines for those with low incomes (–15 per cent), renters (–13 per cent), mortgagors (–10 per cent) and women (–10 per cent)," Mr Evans wrote.
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