The RBA toyed with a 0.5 percentage point rate hike

Underlining the depth of the central bank's concern about the momentum of inflation in the economy, the minutes of the RBA Board's February 7 meeting, released yesterday, show it thought about increasing its cash rate to 3.6 per cent before finally opting for a smaller lift to 3.35 per cent.

According to the minutes, the board was worried about the strength and breadth of inflation and the risk that the longer it persisted, the more likely it became that wage and price expectations would increase, creating a damaging upward spiral that would be very difficult and costly to unwind.

Ultimately, the central bank board judged that the case for a smaller 0.25 of a percentage point lift was "the stronger one" but agreed that "further increases in interest rates are likely to be needed over the months ahead".

The RBA has flagged that developments in the global economy, alongside trends in household spending, employment, labour costs and the pricing behaviour of firms, will be factored in to future monetary policy decisions.

The central bank will get an important economic update on Wednesday when wage data for the December quarter is released.

The index grew at an annual rate of 3.1 per cent in the September quarter and Commonwealth Bank economists tip it will have accelerated to 3.4 per cent in the last three months of 2022.

The central bank has reported that some employers are awarding pay increases of more than 5 per cent and RBA governor Philip Lowe has flagged the risk of a wage-price spiral developing if inflation stays higher for longer.

Wage growth among workers at small and medium businesses is even stronger, according to the Employment Hero SME Index, which draws on data from 90,000 firms. It shows that median hourly wages grew at an annual rate of 7.9 per cent in January, with the biggest gains in construction, health and community services.

The RBA expects wage growth across the economy to accelerate to 4.25 per cent by late this year but the size of any gains is likely to be limited by a slowing jobs market, as indicated by a 0.2 of a percentage point increase in unemployment to 3.7 per cent in January.

But one of the biggest challenges currently facing Reserve Bank economists is trying to gauge the strength of household spending.

Retail turnover dipped slightly in the December quarter but strong demand has helped fuel price increases for services such as travel, accommodation and eating out. Many households are also being hit with big increases in rents and mortgage repayments.

The Reserve Bank thinks the combination of high inflation, rising interest rates and falling house prices will help curb spending.

But the outlook is clouded by uncertainty around whether a massive pool of savings accumulated by households during the pandemic will be hoarded or used to further fuel consumption.

The mood of consumers could be influential, and an ANZ-Roy Morgan study found confidence has improved a little since the rate hike earlier this month, though the index remains at a historically low 80.4 points.

Furthermore, the study found inflation expectations remain well anchored, suggesting people expect the Reserve Bank to succeed in easing price pressures.

Participants in the survey estimated inflation in the next two years would average 5.1 per cent, down from a recent high of 6.8 per cent in November.

ANZ senior economist Adelaide Timbrell said the result showed that the central bank's message about its determination to bring price pressures down was being heeded by consumers.

"They are responding to the very strong Reserve Bank rhetoric about getting inflation under control," Ms Timbrell said.