RBA board split but majority backed raising interest rates to 18-year high

The Middle East conflict and AI boom have intensified the fight to slow price growth, pushing the Reserve Bank to hike interest rates to their highest level since the global financial crisis.

On Tuesday, the bank increased the country’s official interest rate to 4.85 per cent, adding about $100 to a 30-year $600,000 mortgage despite a sharper than expected slowdown in the housing market and worsening unemployment.

Interest rates are now at the highest they have been since November 2008 around the peak of the global financial crisis.

In a major surprise, the vote was 6-3 in favour of the hike, suggesting there is a split in parts of the bank about the direction of interest rates.

In the past week, New Zealand Reserve Bank and the US Federal Reserve split on rate decisions with concerns in both the trade-off between higher interest rates and their impact. There have also been splits on other central banks as they struggle with the inflationary pulse created by the war in the Middle East and the AI construction boom.

The last time the RBA board split was in May when 8 voted in favour of a rate hike with one holding out.

In its latest forecasts, the bank revealed it did not expect trimmed mean inflation – the bank’s preferred gauge of price pressures – to reach the middle of its 2 to 3 per cent target until the June 2028, and that headline inflation would peak at 4.5 per cent by Christmas before beginning to fall.

The bank’s previous forecasts in August predicted inflation to fall steadily over the next two years, with trimmed mean inflation hitting 2.6 per cent by December 2027.

A key issue fuelling higher inflation is the price of oil. In August, the RBA expected Brent to be down around $US76 a barrel. Today, it is $US104 a barrel and has averaged above $US110 for the past two months. The bank’s forecasts on oil still expect oil to cost around $US80 a barrel by the end of 2028.

Another factor is the AI construction boom. Business investment, largely in data centres and computer servers, is expecting to grow by 12 per cent this year. In August, it had expected investment to grow by 4.3 per cent.

AI and computer component companies around the world are pushing through large price rises which are then showing up in higher inflation figures. The bank warned that the AI construction boom could hurt the home construction sector.

“The ramp-up of investment in data centres may also contribute to capacity and pricing pressures domestically, particularly by drawing on resources in the construction industry,” it said.

While several of the cost pressures are driven by international factors, the bank noted capacity constraints in the domestic economy were worse than it had previously thought.

The bank waned that a combination of higher interest rates, higher inflation and the fall in property prices could hit domestic economic activity harder than expected.

It estimates that if consumers start pulling back on discretionary spending faster than forecast, the overall economy could be a full percentage point - or about $28 billion - smaller by the end of 2028 than anticipated.

Unemployment would then likely approach 5.5 per cent, a full half percentage point higher than the RBA is forecasting.

The bank noted that public demand, effectively government spending, was weaker than expected through the first half of this year.

“An easing in public consumption reflected the ending of some temporary cost-of-living measures alongside some moderation in some categories of government spending such as defence and disability and aged care services,” it said.

In August, the bank expected public demand to grow by 3.2 per cent this year. It now expects growth of 2.1 per cent.

But some of that slowdown is likely due to spending being pushed into 2027. In the 12 months to June next year, public demand is expected to grow by 3.8 per cent after previously being forecast to grow by 3.1 per cent.

The bank also said there had been a sharper downturn in the housing market than it had been anticipating, partly driven by government tax changes brought in earlier this year.

More to come

Cut through the noise of federal politics with news, views and expert analysis. Subscribers can sign up to our weekly Inside Politics newsletter.