Yahoo Finance When a recession looms, stop hiking interest rates
There is a strong and growing probability that the world economy will stumble into recession in the next few months.
The effect of the ending of central bank quantitative easing, the absence of fiscal stimulus and the sobering effect of a series of hefty interest rate hikes from most major central banks are sparking an increasingly gloomy outlook for the world economy.
At the same time, household wealth is being destroyed at an alarming rate, with stock markets dropping, house prices weakening and the bond market poised to have one of its worst annual returns ever.
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While such policy tightening has been - and probably still is - essential to expunge the 40-year high for inflation, the debate for central banks - including our own Reserve Bank of Australia (RBA) - about how many more hikes are needed is an explosive topic for markets and policy makers alike.
Bring in the RBA
Australia will be impacted by any global recession. The recession fears are already showing up in commodity prices, which are materially lower, and Australian bonds and shares have been crunched under the weight of the global economic and market ructions.
These will deteriorate further as the global slump intensifies.
It begs a serious question for the future of monetary policy in Australia, especially with the budget on October 25 set to deliver a mildly restrictive impact on economic activity.
The economy is already slowing.
The $1 trillion question is how low growth will fall in 2023 and what impact this will have on what will be an inevitable rise in the unemployment rate.
With just about everyone expecting the domestic economy to weaken further, the RBA should seriously consider holding back on delivering more monetary policy tightening as it works to avoid a self-imposed recession in Australia.
While inflation is currently high and will likely increase further in the next few months - largely on the back of a mechanical pass-through of higher energy prices - any global recession will smash inflation, including in Australia.
It is inevitable. It is obvious.
The only issues for debate are what the peak inflation rate will be and just how quickly it will fall through 2023.
With commodity prices weakening and supply chain problems being resolved, inflation is set to fall in any event.
A recession will completely undermine demand, which will only compound the inflation decline.
Is the RBA awake?
If the RBA is alert to these issues and reflects on the 250 basis points of interest rate hikes it has delivered in the past six months, at the most it has one final 25-basis-point hike to go in the current monetary-policy-tightening cycle.
It probably doesn’t need to hike more than this for inflation to relatively easily move back to the 2-3 per cent target by late 2023 or early 2024.
The RBA does not need to be a major contributor to a recession in Australia by hiking too much, too late in the business cycle.
Indeed, as others have pointed out, there is a lag of at least three months from an RBA hike to its effect on mortgage costs and household cash flows.
It means there are still 125 basis points or so of rate hikes ‘in the system’ which have yet to impact what is already a slowing economy.
Recessions are almost always disinflationary.
When demand slumps and unemployment rises, the ability of firms to pass on higher prices is severely curtailed.
Don’t hike
The RBA delivering one more 25-basis-point hike in either November or December - to 2.85 per cent - will be more than enough to lock in a weaker economy and an impetus to disinflation.
It would be a high-risk strategy – silly even – to hike anything beyond this while ever a global recession is on the cards.
Australia can, in part, fix its inflation pressures by relying on policy errors from other central banks as they crash their economies with super-sized rate hikes.
Australia is in the fortunate position that a prudent and forward-looking RBA can preserve some jobs and businesses by not following that reckless global lead. It can, in large part, piggy-back off the global recession to lower domestic inflation.
And, after pausing on the rate-hiking cycle, if the RBA finds that growth was stronger than it was anticipating or the recession didn’t materialise - and/or inflation was unexpectedly higher for longer - it can resume its hiking cycle around the middle of 2023 with no real damage done.
For now, and in summary, the RBA should hike 25 basis points at its November meeting then sit tight until at least well into 2023.
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