Australia’s central bank raised interest rates by 25 basis points, defying expectations

The Reserve Bank of Australia again defied market expectations on Tuesday, raising its benchmark interest rate by 25 basis points, to 4.1%.

Economists polled by Reuters had widely expected the central bank to keep interest rates steady. Consequently, Australian shares fell further after the news, with the S&P/ASX 200 last trading down 1%. The Australian dollar rose 0.73% to 0.6667 against the US dollar shortly after the decision, with the central bank grappling with the latest inflation rate of $ 6.8% for the month of April.

Reserve Bank of Australia Governor Philip Lowe said that while inflation in the country may have “passed its peak”, there are still indications that inflation will persist.

“Recent data indicates that upside risks to inflation expectations have increased and the Board has responded accordingly,” Lowe said in a statement on Tuesday.

“This further increase in interest rates is intended to provide greater confidence that inflation will return to target within a reasonable time frame,” Lowe added.

The central bank’s target for inflation ranges from 2% to 3%.

“If high inflation becomes entrenched in people’s expectations, it will be very expensive to bring it down later, involving higher interest rates and a larger increase in unemployment,” Lowe said.

The governor’s statement added that there may be further interest rate increases required to bring down the country’s inflation rate, adding that it “will depend on how the economy and inflation develop.”

“Further tightening of monetary policy may be required to ensure that inflation returns to target within a reasonable time frame… The Board will continue to pay close attention to developments in the global economy, trends in household spending, inflation expectations and the labor market,” Lowe said.

The central bank also highlighted the herculean task of avoiding a recession in the Australian economy.

“The Board continues to seek to keep the economy in balance with inflation returning to the target range of 2-3 percent, but the path to achieving a soft landing remains narrow,” it said in the statement.

HSBC’s Paul Bloxham added that the RBA’s goal of achieving a soft landing, or ending the hiking cycle without tipping its economy into recession, is becoming more challenging.

“I think that makes the narrow path that the RBA governor was referring to…that narrow path is getting narrower and narrower as we speak,” he told CNBC’s “Capital Connection” on Tuesday.

In fact, Tuesday’s decision may indicate that a sharp landing is a risk that the central bank is willing to reduce high levels of inflation.

“I think it is harder and harder to believe that Australia will not have more of a slowdown in order to bring down inflation, but the RBA has clearly decided today that those are the risks they are willing to take,” Bloxham said.