Chances of a rate hike in May next year leapt to 91 per cent from 52 per cent prior to the minutes, with the likelihood of a follow-up increase by August 2018 growing.

Shifting sentiment

The shift in sentiment came after officials revealed for the first time that they now believe a cash rate of 3.5 per cent, compared with today's 1.5 per cent rate, would be the level at which the economy could expand at a sustainable 3 per cent or so without generating inflation.

While the internal analysis is largely technical, it highlights that policy makers are beginning to mark out their thinking about what a more normal monetary policy setting would look like once emergency rates are no longer justified.

"All estimates of the neutral real interest rate for Australia suggested that monetary policy had been clearly expansionary for the preceding five years or so," the Reserve Bank said in the minutes.

The remarks, and the fact that the cash rate is now 200 basis points below neutral will begin to push up inflation, were taken by investors as marking a materially hawkish shift.

All eyes are now on deputy governor Guy Debelle's scheduled address in Adelaide on Friday with a speech titled "Global influences on domestic monetary policy", as well as upcoming labour force data for June on Thursday and next week's second-quarter CPI report.

The five-page minutes used the word "positive" eight times​, and noted for the first time that a pick-up in government spending was now expected to be stronger in 2017-18 than previously expected, thanks to a rise in infrastructure projects.


"Members noted that infrastructure investment was expected to have significant positive spillovers to other parts of the economy," the central bank said in the document.

Improving domestic outlook

The dollar strengthened in the wake of the minutes to as much as US79.24¢ from about US78¢ early on Tuesday, sparking forecasts that it will soon clear US80¢ on an improving domestic outlook and a loss of faith over the prospects for more US rate hikes.

Even though policy makers reiterated their longstanding statement of recent years that "an appreciating exchange rate" would hamper the economic transition away from a 10-year mining investment boom, their commentary has made no direct reference to recent gains.

The bank has also repeatedly insisted that the transition is almost complete.

The minutes lend support to speculation that the prospect of an Australian dollar above US80¢ is no barrier to the first Reserve Bank of Australia interest rate increase since 2010.

Goldman Sachs Australia chief economist Andrew Boak said in an interview published Tuesday in The Australian Financial Review that the first hike will happen on Melbourne Cup Day in November as the Reserve Bank joins other central banks in starting the process of removing emergency low monetary policy settings.

The minutes showed that the board continues to be encouraged by strong labour market data, which saw the jobless rate fall to 5.5 per cent in May and offers up a potential recovery in wages growth. Economists expect Thursday's jobs report to show the jobless rate rose in June to 5.6 per cent.


"Members noted that the strength of recent labour market data had removed some of the downside risk in the bank's forecast of wage growth," the bank said.

Board members also noted an improvement in the world economy as a "welcome development".

On the housing market, the bank said it was still too early to know whether a regulatory crackdown on riskier lending would lead to a reduction in the country's high levels of debt, which reached more than 190 per cent of disposable income in the first quarter, a record.

Banks react

National Australia Bank chief economist Ivan Colhoun said the bank's discussion around the neutral rate may reflect where rates ultimately end up as growth recovers and unemployment falls.

However he rejected that it was close to following global counterparts in hiking rates.

"It's likely that – as in 1994 – the RBA will lag the Fed cycle because we have more spare capacity in the labour market," he said.

"The course of unemployment – and underemployment in particular – will be more important for markets in coming months."


Adam Boyton, an economist at Deutsche Bank, said Sydney house prices would likely fall 10 to 20 per cent if the cash rate were to head back to what the RBA thinks is neutral over coming years.

He said that it could get back to 3.5 per cent, but only if the US Fed gets its benchmark rate to 3 per cent from 1.25 per cent.

"That's possible – although we'd expect the RBA to continue to lag the Fed as has been the case to date".