The Reserve Bank is in danger of getting left behind by inflation, which means we’re all in danger of getting left behind by galloping interest rates.
It was a bravely relaxed RBA governor Philip Lowe who appeared before the House of Representative standing committee on economics on Friday.
If I’d been on the committee, I would have asked him: How high will interest rates have to go?
To which he would have replied, with a smile: “That depends.”
And then I would have asked him: Is it true that the later you start raising rates, the higher they will have to go?
And he would have said “that depends” again, because that’s what central bankers say, and then we would all have shouted, in chorus: “Depends on what?” And in the end maybe we would have got a roundabout answer.
But the committee didn’t do any of that, which is a pity, although there was a sort of academic discussion about what the neutral cash rate might be, which is another way of saying where the cash rate will end up, and whether the RBA is at odds with markets on the matter.
Rate hike looms
The market economists, who are paid to be definite with their words, think the cash rate will stop at 1.5 per cent.
Meanwhile the future market traders, who are paid to be definite with their actions, are betting real money that the cash rate will be 1 per cent in November this year, 2 per cent in mid-2023 and that the first hike will happen in July, so four hikes in six months.
The most Dr Lowe was prepared to say about this on Friday, and every other time he has opened his mouth lately, was: “(It is) plausible, if the economy tracks in line with our central forecast, that an interest rate increase will be on the agenda sometime later this year”.
At the risk of being over-forensic with his words, that sounds like one rate hike this year is possible. Four? Out of the question.
Liberal MP Jason Falinski (chair of the committee): “It’s awful how the media pit the two of you (the market and the RBA) against each other, rather than realising that you are in a warm embrace.”
Mr (sic: he’s Dr) Lowe: “I wouldn’t go that far! Andrew [Leigh] asked about learning at the Reserve Bank, and we’re learning all the time. We learn from market prices and the views of the market economists, and they learn from us.”
The RBA and the markets are definitely not in a warm embrace at the moment, and in fact the RBA is increasingly accused of being out of touch with reality.
For example, a Queensland farmer, also named Phil, got in touch with me last week to explain that his namesake at the RBA is bonkers.
He said: “Inflation is out of control in our costs at the moment. Urea is up from $600 a tonne last year to $1500 this year. Glyphosate up from $4.50 litre in July, now $11.50. Tyres up about 20 per cent in seven months. Steel doubled in 12 months.”
A stitch in time
CBA’s head of Australian economics Gareth Aird told me: “If they start a cycle pretty soon it means they don’t have to take monetary policy into contractionary territory.
“If they end up waiting too long and it turns out they’re actually trying to drop the rate of inflation and wages growth ends up going beyond where they want it to get to, they could take it higher.”
In other words, the sooner they start, the lower rates will end up.
Dr Lowe told the committee on Friday that he wants to see two more quarterly CPIs before they act.
That means a rate hike won’t be on the RBA board’s agenda until August 2, which will be a late start. If the cash rate is still 0.1 per cent in August, there’s a fair chance inflation will already be off and running.
The next question is: What is the neutral real cash rate, which is to say the rate that is neither tight nor loose, neither stimulatory or contractionary?
At the moment the real cash is very negative – 0.1 per cent minus 2.6 per cent underlying inflation, so minus 2.5 per cent.
Staying sub-zero
The market is saying, in effect, that the real cash rate will be negative for a long time, since the forward pricing has it at 2 per cent in June 2023, while the consensus forecast for inflation out to 2023 is above 3 per cent.
On Friday, Dr Lowe said: “One would hope that, over time, real interest rates would return to positive territory. If we just get to zero real interest rate then the cash rate would have to average at least 2½ per cent because that’s what we want inflation to average.
“… that would imply, if we’re going to deliver you an average rate of inflation of 2½ per cent, a zero real cash rate would have to have reached 2½ per cent.
“I really hope that we can have higher real interest rates than zero over time as the average, because the real interest rate is fundamentally linked to underlying economic and productivity growth.”
What he means is that you can’t have rising real wages and positive real returns to savers – that is interest rates greater than inflation – unless there’s genuine productivity growth, but there isn’t.
That was the sound of the governor hitting the ball back into the government’s court, since the RBA can’t influence productivity – that’s the government’s job.
And productivity growth has been declining since the Coalition was elected in 2013, which may be a coincidence.
Alan Kohler writes twice a week for The New Daily. He is also editor in chief of Eureka Report and finance presenter on ABC news
