High inflation and some residual resilience in the economy has seen the Reserve Bank (RBA) deliver a further increase to interest rates. This time it was an jump of 25 basis points, which took the cash rate to 2.85 per cent, which is up a substantial 275 basis points since May.
The statement from RBA governor Philip Lowe that accompanied the interest rate hike suggests the RBA is getting close to the end of the rate-hiking cycle.
“A further increase in inflation is expected over the months ahead, with inflation now forecast to peak at around 8 per cent later this year,” Lowe said.
“Inflation is then expected to decline next year due to the ongoing resolution of global supply-side problems, recent declines in some commodity prices and slower growth in demand.”
This is sensible. It is the correct view on the outlook for inflation.
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Lowe also saw the economy slowing over the next 18 months, which was again sensible and obvious.
“Economic growth is expected to moderate over the year ahead as the global economy slows, the bounce-back in spending on services runs its course, and growth in household consumption slows due to tighter financial conditions,” he said.
With the global economy on the cusp of a hard landing – recession, in other words – into 2023, hiking interest rates beyond today’s level would not only be a high-risk strategy that could drag Australia unnecessarily into the global recession, but it would reflect a poor understanding of the future inflation risks, which are looking to ease at a steady pace in line with the weakness in demand, falling commodity prices and the resolution of supply-chain issues.
While the RBA forecast for lower inflation does not include a return to the 2-3 per cent target level, the real-life margin of error in its recent forecasting track record leaves the impression that the risks to its forecast of inflation back around 3-4 per cent over the next two years are squarely to the downside.
Further, the RBA notes that wages growth - while accelerating from the record lows a year ago - remains subdued and little threat to the inflation upside.
Where to now for the RBA?
The critical issues for the RBA in the months ahead can be narrowed down to global conditions, the domestic labour market and the financial health of the household sector.
If these continue to turn lower, the RBA will take the next step in its more cautious approach to interest rates and pause in its hiking cycle. Whether this is a pause in December or its first meeting in 2023 - in February - will be determined, as Lowe noted, by developments in the economy over the next five weeks.
The odds currently suggest a broadly even probability of a rates pause in December, with the next wages and employment data - due in a fortnight - hugely important.
The RBA has some concern about the household sector.
It is being hit with falling wealth as house prices and the stock market weaken, cost-of-living pressures - which are eroding real wages and the purchasing power of savings - the impact on cash flow from the interest rate hikes, and poor confidence levels - which are usually associated with weak consumption spending.
There is a lot of monetary policy tightening in the system. There is a lag from the earlier rate hikes still to impact the economy. The RBA made note of this too.
It is like a sick patient taking medicine for an illness. The patient will not be cured the moment the first tablet is taken.
Not only does it take a while for that to work its way through, but a full course of medicine is needed to cure the sickness.
And it is a similar issue for monetary policy.
The November rate hike will have had zero effect - clearly – but even the hikes on other months have had a marginal impact on the economy to date. They eventually will and that is the reason for RBA caution.
Which all boils down to the point that the end of the rate-hiking cycle is near. The economy is slowing and further moderation in growth is inevitable.
With that will come a turn in inflation pressures, a point that will be greatly assisted by the global recession that is looming.