Interest rates: Why there’s reason for optimism despite the RBA’s pessimism
The immediate future for interest rates appears unclear, thanks to a schism between Treasury and the Reserve Bank (RBA) on the outlook for inflation and unemployment.
Treasury is forecasting inflation to fall earlier and more aggressively than the RBA, while its outlook for the labour market is for a higher peak in the unemployment rate in 2025.
These are important differences. They clearly signal that the RBA is out of touch with its most recent forecasts and, as a result, it has over-egged the extent of its interest rate hiking policy, especially the November rate hike, which took the cash rate to 4.35 per cent.
The difference in economic outlook emerged with Treasurer Jim Chalmers and Finance Minister Katy Gallagher releasing the Mid Year Economic and Fiscal Outlook (MYEFO) – the fancy name for the government’s update on the budget, including for the level of government debt.
In the MYEFO, Treasury’s economic forecasts for inflation and unemployment – the critical drivers of interest rate settings – showed an outlook for lower inflation and higher unemployment than the RBA forecast in its November Statement on Monetary Policy.
Also by the Kouk:
In terms of the inflation forecasts, Treasury is expecting inflation to drop to 3.75 per cent in June 2024 and then to 2.75 per cent in June 2025. The RBA, conversely, is forecasting inflation to ease to 4 per cent and 3.25 per cent, respectively, which is probably why it is retaining what is called ‘a bias to hike interest rates’ when it next meets in February 2024.
For the unemployment rate, Treasury is forecasting it to hit 4.5 per cent in the middle of 2025, compared with the RBA forecast of 4.25 per cent. This more pessimistic outlook from the RBA is likely a reason why Treasury has inflation falling further than the central bank is forecasting.
Usually, differences in forecasts for the unemployment rate and inflation of 0.25 or 0.5 percentage points are not all that important. But, at the moment, when the RBA has been hiking interest rates aggressively - on the back of a more pessimistic outlook for inflation and what is increasingly like an overly upbeat view on the peak in unemployment - these differences are noteworthy and have important implications for the policy outlook.
There could be a relatively straightforward reason for the difference: The latest RBA forecasts were published in early November in its Quarterly Statement on Monetary Policy while the Treasury MYEFO forecasts included data and information released in the month after the RBA’s were finalised.