Economic news in Australia has been dominated by a further increase in inflation and market expectations of further increases in official interest rates by the Reserve Bank of Australia (RBA).

Inflation rises again

September quarter inflation figures showed annual headline inflation rising from 4.0 per cent to 4.3 per cent. Underlying inflation, measured by the RBA's preferred trimmed mean indicator, increased from 3.6 per cent to 3.7 per cent. Both measures remain well above the RBA's 2-3 per cent target range.

While policymakers typically place greater weight on underlying inflation, the headline figure may be particularly relevant on this occasion. Much of the increase reflected higher fuel prices stemming from conflict in the Middle East. If those elevated prices persist, however, they are likely to flow through to broader costs across the economy and eventually into underlying inflation.

Markets were expecting another rate rise

As I write, the November RBA Monetary Policy Board meeting has concluded, with the Reserve Bank increasing the cash rate by 25 basis points on Melbourne Cup Day. Ahead of the decision, bond and swap traders had estimated an 85 per cent probability of a rate hike, while market economists overwhelmingly expected the same outcome. Of the 32 economists surveyed by Reuters, 31 forecast a quarter-percentage-point increase, and all four major Australian banks (ANZ, Commonwealth Bank, NAB and Westpac) anticipated the RBA would raise rates.

The latest inflation data released by the Australian Bureau of Statistics was a key factor behind the decision. It followed a series of hawkish comments from senior RBA officials, which had reinforced expectations that further monetary tightening was likely.

Hauser signals concern on inflation

Recent comments by RBA Deputy Governor Andrew Hauser have reinforced expectations of further policy tightening. Speaking at the Citi Investment Conference on 21 October, he warned that the inflation outlook was "materially worse" than projected in the RBA's August forecasts. He also highlighted growing concerns about inflation expectations, noting that an increasing share of businesses appeared to regard inflation of 3-3.5 per cent as normal, which he described as a "central banker's nightmare". A week later, at Senate Estimates, he characterised the latest inflation figures as simply "too high".

While acknowledging that tighter policy was slowing spending and easing the labour market, Hauser framed the decision as a difficult choice between further tightening, with weaker employment and activity, and waiting, with the risk of inflation becoming entrenched.

New Zealand takes a different path

The last meeting of the Reserve Bank of New Zealand on 28 October concluded with a decision to leave the official cash rate (OCR) on hold at 2.75 per cent. This came with a 4-3 split vote and clearly surprised market participants.

A hike to 3 per cent was almost fully priced into markets, and 22 of 27 economists in Reuters’ poll expected an increase. The New Zealand dollar fell more than 1 per cent after the announcement.

The majority’s rationale was that the previous two increases deserved more time to work. September-quarter inflation had fallen to 3.7 per cent from 4.1 per cent, below expectations, wage growth remained subdued, and medium-term inflation expectations were stable. Weak household spending and risks to the economic recovery also favoured waiting. Nevertheless, the committee still judged further tightening likely, depending on developments.

The Committee said it was focused on: “returning inflation to the 2 per cent target mid-point over the medium term, discounting temporary disturbances to inflation and avoiding unnecessary economic instability.”