The Reserve Bank’s (RBA) decision to leave interest rates steady for a second straight month is a sensible one, given the recent trends in inflation and economic growth, both of which are slowing at a steady and unrelenting pace.
The RBA also took account of the yet-to-be-felt effect of the 400 basis points of interest rate hikes of the past 14 months. And that effect will be substantial.
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It is clear that, already, inflation is falling and economic growth is slowing, and more of this is likely over the remainder of 2023 and into 2024 without the need for any further monetary policy tightening.
The statement from RBA governor Philip Lowe, which accompanied yesterday’s decision to leave rates steady, acknowledged a lot of these factors. And, with further falls in inflation and economic growth, interest rates are likely to be on hold for an extended period. Many months, in other words.
Here are the clues in Lowe’s statement to that effect:
“Higher interest rates are working to establish a more sustainable balance between supply and demand in the economy and will continue to do so.”
“The central forecast is for CPI inflation to continue to decline, to be around 3.25 per cent by the end of 2024 and to be back within the 2–3 per cent target range in late 2025.”
“The Australian economy is experiencing a period of below-trend growth and this is expected to continue for a while.”
“With the economy and employment forecast to grow below trend, the unemployment rate is expected to rise gradually from its current rate of 3.5 per cent to around 4.5 per cent late next year.”
“The recent data are consistent with inflation returning to the 2-3 per cent target range over the forecast horizon and with output and employment continuing to grow.”
In terms of the hard data, the following scorecard is illustrative of the issue:
Inflation from 8.4 per cent in December 2022 to 5.4 per cent in June 2023
Quarterly GDP growth over the past year: 0.8 per cent, 0.6 per cent, 0.6 per cent and 0.2 per cent
Retail sales in quarterly real terms: 0.3 per cent, -0.3 per cent, -0.6 per cent and a forecast of -0.5 per cent for the June quarter
The unemployment rate has been steady around 3.5 per cent for the past 12 months, but forward indicators, such as job ads and vacancies, are falling
Wages growth has picked up but with annual growth of 3.7 per cent, the increase is consistent with the RBA’s 2-3 per cent inflation target
There are a number of key issues in favour of interest rates remaining on hold. Importantly, the global economy is weak, under pressure from policy tightening.
Within Australia, the government is keeping a tight handle on fiscal policy, with the budget registering a $20 billion surplus in 2022-23 and a material smaller deficit in 2023-24. Both of these factors are feeding into slower growth and a return to low inflation.
If, as is likely, official interest rates are on hold for an extended period, the conversation will no doubt turn to ‘when will the RBA cut interest rates?’
On that question, it would be wise to maintain a sober view on the inflation outlook. In other words, an interest rate cut is not yet on anyone’s agenda – it requires two key issues for it to emerge:
Inflation needs to be within the 2 to 3 per cent target with momentum showing it heading towards or below the bottom half of the range
The unemployment rate needs to rise to a level around 4.25 to 4.5 per cent, with annual wages growth hovering around 3.5 to 4 per cent
If, or when, these conditions approach the Australian economy, the RBA will no doubt cut interest rates. This is still some six to 12 months away – perhaps more.
But, for now, a period of many more months where interest rates are held steady by the RBA is on the cards.