The Reserve Bank board considered increasing its key interest rate by 0.50% at its meeting on 5 February, according to minutes released today. In other points:

Indicators of inflation expectations were also tending to rise, which could increase the cost of reducing inflation over time.

They therefore concluded that the outlook for inflation required an immediate response from monetary policy.

The debate focused on whether the change in the cash rate should be 25 or 50 basis points.

Such an increase would have sent a dramatic signal to the market, governments and consumers about the RBA’s level of concern on the looming inflation threat, but the board ultimately decided to lift rates by 25 basis points to 7%. A rise to 7.25% would have pushed the rate to its highest level for over 11 years.

The minutes confirm that another increase of 0.25% is almost a certainty at the board’s 4 March meeting. The 5 February debate centred on whether to go for a big 0.50% rise in February or 0.25% and then another increase in March or at subsequent meetings:

The discussion noted that a good case could be made for the larger move, on the grounds that the inflation outlook had deteriorated and the risk of inflation expectations becoming dislodged had increased.

Thus there was a case for the Board to send a stronger signal of its intention to act as necessary to reduce inflation.

Further, on some measures, the level of the cash rate in real terms arguably was noticeably below what might be expected given the economy’s circumstances.

On this basis, a significant further rise in the cash rate could be necessary.

Members noted that an argument in favour of a rise of only 25 basis points was that the level of rates faced by borrowers had already risen somewhat over the summer, independently of policy action.

A rise of 25 basis points now would produce a total rise over nine months of about 100 basis points for business borrowers and around 90 basis points for housing borrowers.

This was a significant increase over such a period and much of the effect of it was still to be seen.

Additional tightening could be implemented at the March and/or subsequent meetings as judged necessary. Reinforcing this, global credit and equity markets, which the Board considered carefully, had also been unsettled over recent weeks, and the working out of the financial difficulties of the major international financial institutions had some way to run.

To date, the effects of this on Australia had been confined to a significant slowing in the pace at which non-bank corporates and intermediaries could raise funds directly, with the major banks largely making up the difference. But some wider dampening effects could occur over the period ahead, which were difficult to factor into economic forecasts.

The Board judged that the case for the 25 basis point rise was, at this time, the more persuasive. However, the judgment was finely balanced and the Board would continue to review whether policy was sufficiently restrictive to return inflation to the 2–3 per cent target within a reasonable period.