RBA hike out heat on households - the the budget

After April's monetary policy pause and last week's evidence that inflation, while still high, was coming down, it did not seem unreasonable to hope that rate rises may soon be a thing of the past.

That is certainly how markets viewed it. Investors thought there was just an 11 per cent chance the official cash rate would be lifted to 3.85 per cent and 22 out of the 30 economists polled by Bloomberg thought the pause would be extended for at least another month.

But clearly that is not how the Reserve Bank board saw things.

It is not just the fact that inflation, though easing, remains too high. It is that the source of price pressures has shifted and they are now being driven by labour-intensive services.

The fact that this is occurring at a time when the labour market is tighter than it has been in 50 years has the central bank on edge that a damaging and unsustainable explosion in wages could develop - a risk heightened by the fact productivity gains are so poor.

Announcing the rate hike, RBA governor Philip Lowe said economy was set to slow to just 1.25 per cent growth this year - down from the 1.6 per cent it predicted just three months ago.

The implication is that growth will have to decelerate more in order to get inflation down. Inevitably, that means unemployment will go up.

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On Tuesday, Dr Lowe was sticking to the central bank's current expectation that the jobless rate will reach 4.5 per cent by mid-2025. But updated central bank forecasts due out on Friday could change that picture.

The question is whether the Reserve Bank board is reading from the right playbook in assessing the inflation risk, particularly regarding wages.

While labour costs are increasing, even Dr Lowe admits that current gains do not pose a threat.

The RBA Review has recommended the creation of a specialist Monetary Policy Board to inject greater economic expertise into the rates decision process.

Many, including Treasurer Jim Chalmers, think the central bank has been missing important insights into the labour market. His two new board appointments - Dr Iain Ross and Elana Rubin - are intended to help address that.

Hopes that a change of personnel might change things should also be tempered by the fact that the ANU's Shadow RBA Board - comprised of market and academic economists (the very kind of people who might sit on the Monetary Policy Board) - thought a rate rise was the right call.

The hike not only increases the pressure on borrowers.

It is also putting the heat on the government, with calls for it to do more to rein in spending.

The government has flagged that most of this financial year's revenue windfall will go to reducing debt and spending announcements will be offset by cuts elsewhere.

But increasingly others are joining the opposition in saying that is not enough.

Some, such as KPMG chief economist Brendan Rynne, think the government will need to actually pull money out of the system if the nation is to get on top of its inflation problem.

At a time when households are screaming out for help and spending in areas such as defence, disability, aged care and health is surging, that could be a tough call indeed.