After 12 interest rate rises in just over a year, the Reserve Bank now appears confident enough – or uncertain enough – to adopt a new wait and see policy before it decides whether to take up its stated option to tighten further if the inflation numbers suggest it should. That’s largely thanks to the extra two turns of the screw in May and June, in response to upside inflation readings, that lifted the cash rate from 3.6 per cent to 4.1 per cent and provoked demands from Treasurer Jim Chalmers that the Reserve Bank explain itself.
Philip Lowe’s statement on Tuesday dropped the explicit language of Australia having only a “narrow path” to bring down inflation without crashing economic growth. David Rowe
But now inflation has most likely peaked and remains headed back to within the 2 per cent to 3 per cent target by the second half of 2025, on the central bank’s latest forecasts. And the surprising strength of the jobs market, with unemployment revised down to 3.5 per cent, suggests the economy retains a fair amount of momentum. That provides the breathing space to see how the lagged impact of the 4 percentage point increase in the cash rate since May last year plays out. At least for now, the data-dependent approach that governor Philip Lowe says has guided him gives him room to stand back.
Australia’s 4.1 per cent cash rate remains below central bank policy rates in other comparable economies, including the US. And with annual inflation still running at 6 per cent, Australia’s policy rate remains negative in real terms. Notably, Dr Lowe’s statement on Tuesday dropped the explicit language of Australia having only a “narrow path” to bring down inflation without crashing economic growth. Instead, the Reserve Bank is forecasting a base case for GDP growth of 1.75 per cent for 2024 and 2 per cent in 2025: that is, a soft landing. As in the US, the feared recession has so far failed to show. Higher interest rates are imposing pain for housing borrowers with $200 billion in cheap fixed rate mortgages expiring before the end of the year. On the other hand, house prices are rising rather than falling, so borrowers are not facing negative equity.
There are no signs that the Reserve Bank board is thinking tactically about any coming rate increase, such as by getting it out of the way before the new governor Michele Bullock takes up her post before the October board meeting. Instead, there seems to be enough confidence that inflation is decelerating, but with significant uncertainty over softer consumer spending, accelerating nominal wages growth and falling labour productivity, to keep things on hold for a while. Internationally, the world’s two biggest economies are going in opposite directions. In the US, the latest GDP figures showed the economy accelerating to above-trend growth. But China’s economic recovery from its COVID-19 lockdowns has faltered.
Dr Lowe’s new language is that: “Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend on the data and the evolving assessment of risks”. Amid the awkwardly timed baton change in governors, Australia may be managing its inflation breakout. Amid continued cost pressures, however, a softish landing may make it harder to get inflation all the way back down into the band, hence limiting the scope for interest rate relief.
