Yahoo Finance OPINION: Why the RBA made a big mistake keeping the cash rate on hold
The RBA is making a huge mistake keeping official interest rates at a record-low 0.1 per cent.
Inflation is surging, the unemployment rate is set to drop to around 3.5 per cent, a 48-year low and a level that will spark a wages surge which will fuel ongoing inflation pressures into 2023 and possibly beyond.
In looking at the misguided RBA policy inaction on interest rates, it is illustrative to have a look back to what it was thinking and forecasting when it cut rates to 0.1 per cent in November 2020.
That move to record-low rates was made during the COVID crisis.
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The economy was weak, jobs were being lost and inflation was very low.
The interest rate cut was entirely appropriate given those circumstances and the gloomy economic outlook.
With the November 2020 interest rate cut, the RBA said: “Australia is facing a period of high unemployment - the unemployment rate is expected to remain high, but to peak at a little below 8 per cent ... At the end of 2022, the unemployment rate is forecast to be around 6 per cent.
“In underlying terms, inflation is forecast to be 1 per cent in 2021 and 1.5 per cent in 2022.”
It was not good news.
Fast forward to April 2022
When we look at the information before the RBA board at its April 2022 meeting, the Australian economy is massively different to the one it was expecting just 18 months ago.
The strong economy has the unemployment rate at 4.0 per cent and by the end of the year, most forecasters are expecting it to drop to between 3.5 and 3.75 per cent. This is hugely below the RBA forecast of 6 per cent.
Making matters all the more favourable to an even lower unemployment rate is the unrelenting strength in demand for labour. Job vacancies and job advertisements are booming.
Demand for labour has rarely been stronger and this is occurring with the unemployment rate already at historical lows.
Firms are facing labour shortages, wages growth will accelerate as workers extract higher pay for their skills.
This wages growth will be feeding into momentum in inflation which, in headline terms, is set to hit a 30-year high above 6 per cent.
The late 2020 forecast from the RBA for inflation was also hopelessly wrong.
At the end of 2021, underlying inflation was already 2.6 per cent with the annualised rate over the past six months running at 3.5 per cent, well above the RBA target for 2 to 3 per cent.
By the end of 2022, underlying inflation is likely to be 4 per cent, not the 1.5 per cent the RBA was forecasting when it set interest rates at 0.1 per cent.
The big question
It is extraordinary that at the central bank's April meeting it considered the 0.1 per cent cash rate to be appropriate for the current economic conditions and outlook.
It is making a mistake not to start the process of increasing interest rates now.
That mistake will mean inflation will be further unleashed over the next 6-18 months, which will mean an even more draconian stance for monetary policy later in 2022 and into 2023 as the RBA scrambles to bring inflation back under control.
Is it the election?
The only reason the RBA is holding off hiking interest rates is the upcoming federal election, which will be held in May.
An interest rate hike during the election campaign would, of course, be political dynamite but that does not mean the RBA should stop doing its job.
Indeed, the Australian Bureau of Statistics (ABS) will keep publishing data, which will no doubt be used by both sides of the political debate to boost their case on economic-management issues.
It is impossible to imagine the ABS not publishing the inflation or unemployment data during the election campaign because the results might influence voters.
It is the same issue for the RBA as it sets monetary policy with a view to its inflation target and obtaining full employment.
If it wasn’t for the election, there is no doubt the RBA would have hiked already. The economic data have been signalling for some time that the 0.1 per cent cash rate is obsolete.
The politicisation of the RBA is not good news as it means macroeconomic management is taking a back seat to political considerations, and the economy will be worse because of that.
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