By leaving its cash rate unchanged on Tuesday, the Reserve Bank of Australia is betting rate hikes since May have extinguished enough excess demand in the economy to send inflation on a downward trajectory.
Getting that wager wrong, though, could hurt if consumers and businesses figure borrowing costs have peaked and pile back into markets for everything from household goods to houses.
Such a sentiment shift could slow or reverse inflation’s slide back towards the 2%-3% range the RBA is currently required to target over time. Overseas experience, such as in the UK, suggests a slowing pace of price rises can’t be taken for granted.
Australia, remember, was late to start lifting interest rates, beginning only last May. By then, most overseas counterparts had been tightening for some months.
The RBA in October also became the first major central bank to pare the size of rate increases, halving them to 25 basis points. And with Tuesday’s pause, Australia joins Canada as among the first nations to halt the hikes.
At 3.6%, the RBA’s official cash rate remains relatively low in nominal terms. (Japan has been in a deflationary torpor for more than three decades.)
The RBA governor, Philip Lowe, will doubtless expand at Wednesday’s National Press Club address on the board’s reasons for halting the record run of 10 rate rises.
Given Lowe’s performance over recent years, though, journalists may well ask why the public should have confidence he’s picked the right time to pause.
Lowe has already conceded he was wrong to say the RBA’s cash rate could remain at its record low 0.1% until 2024. As late as November 2021, he was still saying “the economy and inflation would have to turn out very differently” for the board to even consider any increase in interest rates in 2022, even as other nations were moving.
To be sure, nobody anticipated the impact Russia’s invasion of Ukraine would have on global inflation, largely causing the eight RBA rate rises that followed in 2022.
Still, Lowe’s explanation for Australia’s exceptionalism was dubious in late 2021. The limited details we have so far as to why a pause now is appropriate also raise doubts.
Eighteen months ago Lowe was confident Australia’s labour market would be less affected by Covid than, say, the US. Worker shortages wouldn’t be as bad, he reasoned, so wages wouldn’t bump up as much as economies emerged from the pandemic.
Australia, too, was relatively shielded from soaring energy prices that were already causing economic pain in Europe and elsewhere, Lowe said. Recall, these comments preceded the Russian attacks.
Since then, Australia’s jobless rate has fallen faster than the RBA’s and others’ forecasts and remains hovering at near half-century lows.
The staggered nature of our multi-year employee agreements – and restrictions of industrial action – have so far helped limit wage growth. It remains “consistent with the inflation target”, the RBA says.
However, with the Australian Council of Trade Unions calling for a 7% rise to the minimum wage and the federal government indicating it wants real wages to remain at least steady, the wage price index is more likely to keep rising rather than fall.
Energy prices, of course, have been a nasty surprise for everybody who’s not a producer. Increases in power prices of about 20% in the past year look likely to reach 30% in one state from July.
Rents, meanwhile, “are increasing at the fastest rate in some years, with vacancy rates low in many parts of the country”, the RBA said.
For these reasons and others, many economists predict the RBA rates haven’t peaked.
“We continue to think inflation will prove persistent enough to require the RBA to tighten monetary policy further in the months ahead,” Felicity Emmett, a senior economist at the ANZ, said. “In our view, the question is not so much one of ‘where’ the RBA gets to – we still favour 4.1% as the terminal rate – but ‘when’ it gets there.”
Borrowers’ relief at Tuesday’s pause, in other words, may well prove temporary.
