Advertisement
Australia markets open in 7 hours 4 minutes
  • ALL ORDS

    8,166.40
    -42.80 (-0.52%)
     
  • AUD/USD

    0.6641
    -0.0044 (-0.66%)
     
  • ASX 200

    7,931.70
    -39.90 (-0.50%)
     
  • OIL

    80.06
    -0.07 (-0.09%)
     
  • GOLD

    2,392.60
    -6.50 (-0.27%)
     
  • Bitcoin AUD

    101,150.51
    -649.53 (-0.64%)
     
  • CMC Crypto 200

    1,378.07
    -27.27 (-1.94%)
     

RBA on 'cusp' of major mistake for interest rates: 'Defies wisdom'

The RBA is shying away from interest rates cuts despite the data and, importantly, risks.

RBA governor Michele Bullock and interest rates
The RBA is falling behind the curve for previous interest rate cuts, economist Stephen Koukoulas says. (Source: AAP/RBA)

Since 1990, there have been five interest rate cutting cycles in Australia. The last four of those were after 1993 when the Reserve Bank of Australia (RBA) embraced the target for annual inflation of 2 to 3 per cent.

The decision to start an interest rate cutting cycle is always a momentous one for the RBA. It takes the step to start a monetary policy easing cycle when it is confident inflation is expected to be in the target range and there is a serious risk of rising unemployment.

This is all simple and rather obvious.

Or is it?

RELATED

ADVERTISEMENT

Despite the huffing and puffing from a few noisy and badly misplaced commentators that the next move in interest rates will be up, investors are banking on interest rate cuts over the next 12 to 18 months - not hikes.

The reasons for this investor confidence are rather straightforward. The current inflation rate WILL keep falling as depressed economic growth, rising unemployment, the deceleration in wages growth and global economic conditions continue to impact price pressures.

For some, there is a feeling that the RBA will need to see inflation falling yet further before cutting interest rates.

This view is ignorant of history and indeed, how the RBA previously functioned when managing its dual goals of low inflation and full employment.

Do you have a story to share? Contact yahoo.finance.au.yahooinc.com

The RBA is falling behind the curve for an interest rate cut

It is well known and very obvious that interest rate changes take many months to fully impact economic activity and inflation. The well-established view is that an interest rate change today will take anywhere from six to 18 months to have its full effect. This is a timeframe the RBA knows well and should be acting on.

Which brings us back to the start of past interest rate cutting cycles.

The table below shows something that defies conventional wisdom, as facts often do. Implicitly, it shows that the RBA is on the cusp of making a big policy error by keeping interest rates too high in the face of moribund GDP growth and rising unemployment.

Some basic facts:

At the start of every interest rate cutting cycle (with the possible exception of February 2001, which was distorted by the price effects from the introduction and extension of the goods and services tax) inflation has been above 3 per cent.

At the same time, the unemployment rate has been flat or falling when rates were first cut.

Further, the rate of GDP growth has been solid, and clearly not an impediment to rates being cut.

As the data stand at the moment, annual inflation is running at 3.6 per cent, not too far from the levels at the start of earlier rate cutting cycles. At the same time, the unemployment rate is 0.5 percentage points higher today than a year ago, which is in stark contrast to the position on every other cycle.

What's more, GDP growth is currently disastrously weak, below the growth rate recorded at the start of every other rate cutting cycle.

Date of first interest rate cut

Inflation % y/y at the time of decision

Change in unemployment rate in prior 12 months

GDP growth% change y/y

January 1990

7.8% #

-0.7 percentage points

5.6%

July 1996

3.1%

-0.1 percentage points

4.4%

February 2001

5.8% *

-0.7 percentage points

3.3%

September 2008

4.4%

-0.3 percentage points

2.9%

November 2011

3.4%

-0.1 percentage points

2.5%

To be decided – latest data

3.6%

+0.4 percentage points

1.1%

#Prior to the introduction of the 2-3% inflation target.

*Inflation was boosted by approximately 3 percentage points due to introduction of GST.

It begs a question, why the RBA is so reluctant to consider an interest rate cut at the moment when the data flow and, importantly, risks say it should be cutting?

The RBA rhetoric

The RBA is shying well away from interest rate cuts because of one issue – its perceptions of inflation.

It is all but ignoring rising unemployment with this sort of gobbledygook in its most recent Monetary Policy Decision:

  • “Conditions in the labour market eased further over the past month but remain tighter than is consistent with sustained full employment and inflation at target”

We will see about that, particularly with the fact that wages growth is already slowing in the wake of the weak economy and the rise already seen in unemployment.

The slide in GDP growth barely rated a mention in the latest RBA statement – there was this lame comment that “output growth has been subdued, and consumption per capita has been declining” without any reference to how severe the weakness was with annual GDP growth of just 1.1 per cent and what this meant for future trends in unemployment and inflation.

The RBA also noted on inflation: “The process of returning inflation to target is unlikely to be smooth” and “the persistence of services price inflation is a key uncertainty”.

In other words, the RBA has little confidence about its inflation forecasts being anywhere near correct, even though it is using its analysis of inflation not to cut interest rates.

So why wait to cut interest rates if inflation could be lower than currently forecast?

All up, it is clear the RBA is breaking with tradition and, strangely, that it is being spooked by the time it is taking for inflation to return to the target. This is despite the unarguable facts that economic growth and the change in the unemployment rate are consistent with inflation returning to target very soon and, importantly, inflation is tracking MUCH lower as the RBA has been forecasting for the past year.

The mistake the RBA is making by keeping interest rates too high for too long is to underpin a further rise in unemployment with further weakness in economic conditions.

It is unlikely to end well.

Get the latest Yahoo Finance news - follow us on Facebook, LinkedIn and Instagram.