Not content with weakening economic growth, falling inflation, weak wages growth and a certain rise in the unemployment rate, the Reserve Bank (RBA) chose to shock the economy with a further 25-basis-point interest rate hike after its May board meeting.
That makes a record 11 interest rate increases in a year, totalling 375 basis points, which is also a record for the largest cumulative rate hikes since at least the early 1990s. Monetary policy settings are clearly very restrictive.
Also by the Kouk:
The decision of the RBA to hike was a shock because the full effect of the previous 10 rate hikes had yet to fully impact the economy.
When pausing the hiking cycle in April, governor Philip Lowe noted: “Monetary policy operates with a lag and … the full effect of this substantial increase in interest rates is yet to be felt. The board took the decision to hold interest rates steady this month to provide additional time to assess the impact of the increase in interest rates”.
Four weeks since Lowe said that seems a very short time to make that assessment of the lags - especially when, in that time, inflation fell, retail sales were again weak, the unemployment rate was stable and the leading indicators such as job advertisements were trending down.
The beleaguered Lowe - who very likely has only four months left in the job - risks adding ‘recession’ (or something close to it) to the errors made under his watch.
Taking the RBA forecasts out to mid-2025 as a benchmark, under Lowe’s management, inflation will have been within the 2-3 per cent target for just six months of the more than 9 years he has implemented monetary policy.
A dismal result.
While a recession remains a low probability and is not front and centre of most forecasts, if the restrictive stance of monetary policy is accompanied by a tight budget next week from Treasurer Jim Chalmers, the growth outlook will sour from an already-fragile starting point. Lifting interest rates too much too late in the economic cycle is a recipe for troubling economic times.
Lowe’s statement accompanying the interest rate rise was a potpourri of comments that did not support the decision to further hike rates.
While these are selective quotes from Lowe, they are telling:
“Inflation in Australia has passed its peak … [and] the recent data showed a welcome decline in inflation.”
“There has been some easing in labour shortages and the number of vacancies has declined a little.”
“At the aggregate level, wages growth is still consistent with the inflation target.”
“The board is still seeking to keep the economy on an even keel.”
“The central forecast is for the economy to continue growing, albeit at a below-trend pace; GDP is forecast to increase by 1.25 per cent this year and around 2 per cent over the year to mid-2025.” [Author’s note: with annual population growth around 1.5 per cent over the time line mentioned, per-capita GDP growth will be around zero for more than two years, if all goes according to the RBA plan. A per-capita recession?]
“The unemployment rate is forecast to increase gradually to be around 4.5 per cent in mid-2025.”
“While some households have substantial savings buffers, others are experiencing a painful squeeze on their finances. There are also uncertainties regarding the global economy, which is expected to grow at a below-average rate over the next couple of years.” [Author’s note: these two throwaway lines near the end of Lowe’s statement are actually at the crux of the issue. Weak household spending - which makes up more than half of GDP - could weaken further, and the global economy is vital for trade sentiment and commodity prices and it is weak]
With that assessment from the RBA itself, it is easy to see why the markets and most economists were shocked by the decision to hike for an 11th time.
The RBA is playing with fire and the risk of an economic hard landing is growing with each tightening in policy.
If, as seems likely, the economy stalls in the second half of 2023 and into 2024, inflation will fall more rapidly than the RBA currently expects. That is when the new RBA governor and her board will contemplate a reversal of the restrictive monetary policy settings – cutting interest rates in other words.