Rate hikes needed to curb inflation: RBA

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Reserve Bank of Australia Governor Philip Lowe has warned further interest rate increases can be expected in coming months to tackle inflation after raising the cash rate for the first time in over a decade.

The RBA raised the cash rate from a record low 0.1 per cent to 0.35 per cent at Tuesday's monthly board meeting, a larger increase than economists had been expecting after last week's strong inflation numbers.

The annual rate of inflation surged to 5.1 per cent and underlying inflation hit 3.7 per cent, well above the RBA's two to three per cent inflation target.

"If interest rates were to remain unchanged, inflation would be higher than this, perhaps substantially higher," Dr Lowe told reporters in Sydney during a rare press conference following the board meeting.

Tuesday's announcement was the RBA's first rate increase since November 2010, having held the rate at a record low 0.1 per cent since November 2020.

But Dr Lowe was reluctant to predict how quickly interest rates would rise from here.

"It's not unreasonable to expect the normalisation of interest rates over the period ahead could see them rise to 2.5 per cent," he said, matching the middle of the inflation target.

"How quickly we get there, and if we do get there, will be determined by how events unfold."

Financial markets are already pricing a cash rate of over 0.6 per cent at the June board meeting.

AMP chief economist Shane Oliver expects the cash rate to rise to 1.5 per cent by year-end and to two per cent by mid next year.

"But the RBA will only raise rates as far as necessary to cool inflation and high household debt has likely made rate hikes more potent," Dr Oliver said.

It was the first time the cash rate has increased during an election campaign since 2007 - a poll former Liberal prime minister John Howard went on to lose after campaigning on lower interest rates under his government.

Dr Lowe said the May 21 election had no influence on the board's decision, which has a mandate by parliament to achieve price stability, full employment and promote the economic welfare of the Australian people.

"We have operational independence and it's testimony to the political culture of Australia that the independence is respected. We take our decisions in the best interest of the country," he said.

If retail banks follow the RBA's signal it would add around $75 per month to repayments on a standard variable rate $500,000 mortgage.

CBA was the first of the big four banks to hike its variable home loan rates, saying it would pass on the full 0.25 percentage point increase on May 20.

The Morrison government put on a brave face given its campaign advertising boasted interest rates have been lower under the Liberals than Labor over the past 30 years.

"We don''t have an axe to grind with the Reserve Bank, they are independent of government," Treasurer Josh Frydenberg told reporters in Melbourne.

"They have to make decisions based on what they are seeing through the economy."

But shadow treasurer Jim Chalmers said it was a tough day for Australians.

"This is another aspect of Scott Morrison's triple whammy in his cost of living crisis - falling real wages, rising inflation rates and inflation rising out of control," he told reporters in Canberra.

Consumer confidence was already in decline following the spike in inflation and before the RBA's rate decision, a warning to retailers in a rising interest rate environment.

The weekly ANZ-Roy Morgan consumer confidence index - a pointer to future household spending - tumbled six per cent, the biggest drop since mid-January when the COVID-19 Omicron variant surged.

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