The recently departed head of research says the RBA should have hiked rates higher to head off inflation, and the Board lacked the expertise to challenge the governor on rate decisions:
Acknowledgments
- Chris Joye: RBA story in the AFR
Australian Outlook | Chris Joye
Central banks are too much under the sway of government and not doing enough to contain inflation. None worse than the RBA which is holding rates lower than they should be. The last time that we had inflation at 4.0% in 2008, the cash rate was 7.25%. Now the cash rate is only 4.35%.
RBNZ is far more independent and hiked their official cash rate to 5.5%. The NZ economy is in recession but they still face the threat of stagflation, with low growth and high inflation.
In Australia we have a negative output gap, where demand exceeds production capacity, far worse than in most other major economies. The only solution is to raise unemployment to lower demand. But RBA governor Michelle Bullock has publicly stated that the RBA is not looking to reduce employment.
The latest Australian government budget is highly stimulatory and likely to fuel further inflation.
The outcome is likely to be long-term inflation and higher long-term interest rates.
Conclusion
We expect strong inflationary pressures in the next decade as governments run large fiscal deficits. Additional government spending is needed to:
- Address the energy transition from fossil fuels to renewables and nuclear;
- On-shore critical supply chains; and
- Increase defense spending in response to geopolitical tensions.
Long-term interest rates are expected to rise over the next decade, fueled by higher inflation.
Central banks may attempt to suppress interest rates by further expanding their balance sheets to buy long-term fiscal debt but that is short-sighted. Inflation would accelerate even higher.
Apart from the hardship to wage-earners, and the subsequent political chaos, high inflation would threaten bond market stability. Bond market investors would be reluctant to fund deficits when interest earned is below the inflation rate. Unless there are no alternatives.
That is why the long-term outlook for gold and silver is so bullish.
Australian CPI falls but no rate cuts in sight
Quarterly CPI fell to 4.1% for the 12 months to December, while the trimmed mean is not far behind at 4.2%.
Household rent increases remain strong, however, boosted by a surge in immigration.
Conclusion
Inflation, apart from rents is generally falling as the economy slows. But the RBA is unlikely to cut rates soon unless we see a sharp contraction in household consumption.
Westpac and CBA call a rate hike
Luci Ellis, new Chief Economist at Westpac, believes the inflation overshoot in September was enough to expect an RBA rate hike:
Last week we noted that the RBA would leave rates unchanged so long as they saw inflation coming down as they had expected. But if the data flow showed inflation declining slower than that, they would raise rates. This message was reinforced in the Governor’s first speech, on Tuesday, where she said “The Board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation.” The September quarter CPI release was always going to be crucial.
Has the RBA seen enough to move? At 1.2% in the quarter, both headline and trimmed mean inflation was a little higher than the Westpac team expected (see Westpac Senior Economist Justin Smirk’s note). We assessed that it would take a significant upside surprise to induce the RBA Board to raise rates at the November meeting. A 0.1% difference might not seem like a lot, but the underlying detail was sobering.
So yes, I’ve seen enough to make my first-ever rate call to be a prediction of a hike. (Westpac)
Gareth Aird and Stephen Wu at CBA expect the RBA to raise the cash rate by 25bp (to 4.35%) on Melbourne Cup day:
The RBA has a hiking bias. And on Tuesday night, RBA Governor Bullock stated, “the Board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation”.
We are not sure what constitutes a ‘material upward revision’ to the RBA’s inflation forecasts. But we consider the lift in underlying inflation over Q3 23 to be sufficiently strong for the RBA to act on their hiking bias at the upcoming Board meeting. (Commbank Research)
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RBA tapers
From Bill Evans at Westpac:
The Governor of the Reserve Bank has announced the intention to reduce the weekly purchases from $5 billion to $4 billion and not to extend its Yield Curve Target from the April 2024 bonds to the November 2024 bonds – two clear signs that policy is tightening…..
The decision to not extend the Yield Curve Target program to the November 2024 bonds….Giving up the option to extend the purchases at 0.1% to a 3 year 4 month bond from a 2 year 9 month bond, is effectively tightening policy.
Australia needs to break the downward spiral
Ross Gittins, Economics Editor at The Sydney Morning Herald, sums up Australia’s predicament:
“The problem is, the economy seems to be running out of puff because it’s caught in a vicious circle: private consumption and business investment can’t grow strongly because there’s no growth in real wages, but real wages will stay weak until stronger growth in consumption and investment gets them moving.
Policy has to break this cycle. But, as [RBA governor] Lowe now warns in every speech he gives, monetary policy (lower interest rates) isn’t still powerful enough to break it unaided. Rates are too close to zero, households are too heavily indebted, and it’s already clear that the cost of borrowing can’t be the reason business investment is a lot weaker than it should be.
That leaves the budget as the only other instrument available. The first stage of the tax cuts will help, but won’t be nearly enough…..”
Cutting already-low interest rates is unlikely to cure faltering consumption and business investment. Low wage growth and a deteriorating jobs market are root causes of the downward spiral and not much will change until these are addressed.
Low unemployment is misleading. Underemployment is growing. Trained barristers working as baristas may be an urban legend but there is an element of truth. The chart below shows underemployment in Australia as a percentage of total employment.
How to halt the spiral
Tax cuts are an expensive sugar hit. The benefit does not last and may be frittered away in paying down personal debt or purchasing imported items like flat-screen TVs and smart phones. Tax cuts are also expensive because government is left with debt on its balance sheet and no assets to show for it.
Infrastructure spending can also be wasteful — like school halls and bridges to nowhere — but if chosen wisely can create productive assets that boost employment and build a healthy portfolio of income-producing assets to offset the debt incurred.
The RBA has already done as much as it can — and more than it should. Further rate cuts, or God forbid, quantitative easing, are not going to get us out of the present hole. What they will do is further distort price signals, leading to even greater malinvestment and damage to the long-term economy.
What the country needs is a long-term infrastructure plan with bipartisan support. Infrastructure should be a national priority. There is too much at stake for leadership to take a short-term focus, with an eye on the next election, rather than consensus-building around a long-term strategy with buy-in from both sides of the house.
Westpac’s Bill Evans predicts record rate cuts
Australia: RBA hands tied
Falling wage rate growth suggests that we are headed for a period of low growth in employment and personal consumption.
The impact is already evident in the Retail sector.
The RBA would normally intervene to stimulate investment and employment but its hands are tied. Lowering interest rates would aggravate the housing bubble. Household debt is already precariously high in relation to disposable income.
Like Mister Micawber in David Copperfield, we are waiting in the hope that something turns up to rescue us from our predicament. It’s not a good situation to be in. If something bad turns up and the RBA is low on ammunition.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. The blossom is blighted, the leaf is withered, the god of day goes down upon the dreary scene, and — and in short you are for ever floored….
~ Mr. Micawber in Charles Dickens’ David Copperfield
RBA stuck
Great slide from the NAB budget presentation:
The RBA is in a cleft stick:
- Raising interest rates would increase mortgage stress and threaten stability of the banking system.
- Lowering interest rates would aggravate the housing bubble, creating a bigger threat in years to come.
The underlying problem is record high household debt to income levels. Housing affordability is merely a symptom.
There are only two possible solutions:
- Raise incomes; or
- Reduce debt levels.
Both have negative consequences.
Raising incomes would primarily take place through higher inflation. This would generate more demand for debt to buy inflation-hedge assets, so would have to be linked to strong macroprudential (e.g. lower maximum LVRs for housing) to prevent this. A positive offshoot would be a weaker Dollar, strengthening local industry. The big negative would be the restrictive monetary policy needed to slow inflation when the job is done, with a likely recession.
Shrinking debt levels without raising interest rates is difficult but macroprudential policies would help. Also policies that penalize banks for offshore borrowings. The big negative would be falling housing prices as investors try to liquidate some of their investments and the consequent threat to banking stability. The slow-down in new construction would also threaten an economy-wide down-turn.
Of the two, I would favor the former option as having less risk. But there is a third option: wait in the hope that something will turn up. That is the line of least resistance and therefore the most likely course government will take.
Did the RBA just signal the end of rate cuts?
From Jens Meyer:
Did the RBA just signal the end of rate cuts and no-one noticed?
Well, not exactly no-one. Goldman Sachs chief economist Tim Toohey reckons the speech RBA assistant governor Chris Kent delivered on Tuesday amounts to an explicit shift to a neutral policy stance.
Dr Kent spoke about how the economy has been doing since the mining boom, and in particular how its performance matched the RBA’s expectations.
Reflecting on the RBA’s forecasts of recent years, Dr Kent essentially framed the RBA’s earlier rate cut logic around an initial larger than expected decline in mining capital expenditure and subsequent larger than expected decline in the terms of trade, Mr Toohey said.
Having so closely linked the RBA’s easing cycle to the weakness in the terms of trade (and earlier decline in mining investment), Dr Kent’s key remark was to flag “the abatement of those two substantial headwinds” and highlight that this “would be a marked change from recent years”….
Source: Did the RBA just signal the end of rate cuts and no-one noticed?