Despite the independence of central banks, there’s no getting politics out of monetary policy.
In Australia, the best inflation report in more than two years for the December quarter is now widely tipped to prompt the Reserve Bank’s final board meeting in mid-February to cut interest rates. But it is fundamentally caught up in the politics of the coming election. A failure to cut rates will be interpreted, rightly or wrongly, as a political act, one against the interests of the Labor government. That will have potentially grave implications for the central bank’s independence.
If we don’t want to go down the US route — where a populist leader comes to power decrying central bank independence and demanding political control in order to push down interest rates — the RBA must avoid any suggestion it is either partisan or so narrowly ideologically fixated that it refuses to accept clear evidence that inflation is now normalising.
Underlying inflation fell to an annual 3.2% in the December quarter from 3.6% in the previous quarter, and the headline rate dropped to 2.4% from 2.8%. The headline rate is now well within the RBA’s target range for inflation of 2-3% “over time”, and well below headline inflation in the US –2.9% — where the Federal Reserve has been cutting rates for months.
The measure of core inflation, the trimmed mean, increased by just 0.5% in the December quarter, the smallest rise since mid-2021. The RBA is now all out of excuses not to start reducing its economically damaging and ill-considered attack on households. But then, it was out of excuses in December and still stolidly refused to consider a cut.
The intersection of politics and monetary policy has also been on show in America, where the Federal Reserve brought its current program of rate cuts — once expected to extend well into 2025 — to a halt in the face of the chaos of the mad king’s court. Despite Trump’s ranting for interest rate cuts (not just in the US, but globally), a rate cut overnight while US inflation remains above the Federal Reserve’s target might have panicked markets as evidence the US economy was in trouble under an erratic new administration. Instead, markets were flat as investors worked out that interest rates might be on hold for a while — and that neither cuts nor rises were off the table for 2025.
Trump’s much-hyped but yet-to-be-delivered tariffs — even under a program of slow escalation, as proposed by new Treasury Secretary Scott Bessent — will be inflationary. His administration, however, also risks slamming the US economy into a wall with ham-fisted measures like the anti-woke freeze in government payments revealed on Tuesday, which blew up in Trump’s face and forced the administration into a backdown. Turns out the war on woke will have to be put on hold to make sure it doesn’t harm state governments and 90 million users of Medicaid.
Along with the impact of the DeepSeek revelation and its potential negative impact on AI and energy investment, it all amounts to a period of significant uncertainty for the US economy, requiring a “steady as she goes” approach from the Fed, regardless of how much Trump demands the waves roll back.
Significantly, the Fed’s post-meeting statement dropped a reference from its December statement that inflation “has made progress toward” the 2% inflation goal — which immediately saw some economists trim their rate cut forecasts for the year. “The unemployment rate has stabilised at a low level in recent months, and labour market conditions remain solid,” the new paragraphs read. “Inflation remains somewhat elevated” and the economy “has continued to expand at a solid pace”.
Chair Jerome Powell also made the key point in his media briefing that the solid labour market has not been a significant source of inflationary pressure. We’re not the only country where a wage-price spiral — beloved by right-wing economists — hasn’t appeared.
It should be remembered that the Fed beginning to cut interest rates before the November election didn’t do anything to help the Democrats, and a rate cut here may not do much to help Labor — although interest rates have much less impact on US homeowners than in Australia, where variable mortgage rates are the norm. But a failure to cut will do enormous damage to the Reserve Bank.
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