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Interest rate hike lag spells more pain before cries for cuts answered: 'Smells like a recession'

The RBA announced steady interest rates at its June meeting and looks unlikely to hike rates again.

Michele Bullock on top of a stylised image of pedestrians and the skyline
The Reserve Bank of Australia knows it has to squeeze Aussies to pull out of an inflation nosedive, but how far is too far? (Yahoo Finance Australia/Belinda Grant-Geary)

Whichever way you cut the economic data, there is grim news on the economy. It is a scorecard that smells like a recession.

The interest rate hiking cycle which started in May 2022 has worked. It was designed to weaken the economy, push unemployment higher, wage growth lower and with that, drive inflation down.

This has happened.

But interest rate changes work with a lag – a rate hike today can take up to 12 to 18 months to impact the economy. This means there are rate hikes from 2023 that have yet to have their full effect.

In the year since June 2023, the Reserve Bank of Australia (RBA) has hiked interest rates once, by 25 basis points in November 2023, as it sees depressed economic conditions, a topping out in wage growth, falling inflation and rising unemployment.



And the RBA knows the lags involved and does not want to inflict more financial grief on the economy.

At the end of the day, investors are still preparing for interest rate cuts, not immediately, but over the next six to 18 months.

Markets can get it wrong and overshoot from time to time, but there are currently two interest rate cuts expected in the next 12 to 18 months as the economic funk now being seen drives inflation lower.

Retail sales growth is tracking at near record lows; the number of dwelling building approvals has slumped to a decade low; GDP growth is at a three decade low (outside the COVID blip); the unemployment rate is trending up; job vacancies are falling and business insolvencies are rising.

Even wage growth is at a turning point – lower.

Business confidence, which was solidly resilient up until the middle of last year, is nosediving in reaction to the deluge of disappointing news.

You can feel fears of a recession when looking at per capita GDP growth, which has fallen for five consecutive quarters.

While the RBA and frankly all of us would like to see inflation back in the target range now, rather than in a few quarters, it still is falling.

The grim economic news is confronting. Announcing steady interest rates at its June Board meeting, the RBA noted:

  • “Conditions in the labour market eased further.”

  • “Wages growth appears to have peaked.”

  • “Output growth has been subdued, and consumption per capita has been declining, as households restrain their discretionary expenditure.”

  • “The economic outlook remains uncertain and recent data have demonstrated that the process of returning inflation to target is unlikely to be smooth momentum in economic activity is weak, including slow growth in GDP, a rise in the unemployment rate and slower-than-expected wages growth.”

  • “Returning inflation to target within a reasonable timeframe remains the Board’s highest priority. This is consistent with the RBA’s mandate for price stability and full employment.”

To be sure, these quotes are selective, but they carry a huge amount of weight in the economic outlook and underpin why the RBA is unlikely to be hiking interest rates and why lower interest rates are likely. It would not have noted these issues if they were not important.

Even Treasurer Jim Chalmers mentioned the damaging effects of the RBA’s current stance on monetary policy when he noted:

  • “Our economy is slowing as a result of higher interest rates, which are already hammering consumption growth.”

  • “The Budget forecast consumption to grow by only ¼ per cent this year – when it usually grows around 2½ per cent.” (my emphasis)

When the RBA does start its interest rate-cutting cycle, it will be in good company – already the Eurozone, Canada, China, Sweden and Switzerland, among others, have been cutting interest rates.

Cuts are all but certain in the UK, US and New Zealand before year-end.

Those central banks are facing virtually all the same conditions that are being experienced in Australia.

You don’t have to be too extreme to think the RBA will join the rate-cutting party – economic weakness, rising unemployment and inflation demand it.

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