Yahoo Finance Why the RBA should keep interest rates on hold
Slower growth means lower inflation but where to now for interest rates?
The news on the economy in the past two weeks is showing that a slowdown is unfolding.
There is severe weakness in retail spending and housing construction, a slowing in demand for labour, an uptick in the unemployment rate and a budget that has delivered a surplus.
When the March-quarter economic-growth numbers are released next week, they are likely to show a quarterly rise of around 0.3 per cent, which is a soggy result given population growth is around 0.5 per cent per quarter, and given it follows growth of just 0.5 per cent in the December quarter.
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What this means is that annualised growth will be slipping towards 1.5 per cent - a marked slowdown in anyone’s language.
And so it is with the inflation rate, which is easing from what was a 32-year high of 8.4 per cent in the year to December 2022.
The April monthly Consumer Price Index (CPI) confirmed annual inflation at 6.8 per cent, a little higher than market economists were forecasting. The ‘high’ headline result masks a more substantial slowing in inflation since the end of 2022.
While there are still the effects of petrol prices rising and flood-related food price hikes - which were evident during the middle to latter part of 2022 - these sharp price hikes will drop out of the year-on-year inflation rate through the course of 2023, which will confirm inflation is tracking low.
How to assess the inflation deceleration
One way to accurately assess the inflation deceleration is to look at the change in the CPI since December 2022.
Over the four months since the end of 2022, the CPI has increased by a cumulative total of 1.1 per cent. This translates to an average monthly increase of 0.275 per cent, which is an annualised pace of just 3.3 per cent.
The Reserve Bank (RBA) will be happy with this result.
It should also be noted that some of the upside in the April inflation reading was largely due to a jump in petrol prices and the cost of holiday travel.
This is noteworthy because retail petrol prices have dropped sharply in May and airfares are lower after the holiday-inspired boost in April.
These two items alone will push the monthly May inflation reading materially lower which, on current figuring, will see the annual increase in the CPI drop to around 6.2 per cent.
Inflation still on track to hit 3%
The slower rate of economic growth, the global downturn and the drop in commodity prices are still very much in place. A simple extrapolation of these trends into the inflation forecasts points to materially lower inflation through 2023 and into 2024.
The RBA is forecasting inflation to ease to 3 per cent by 2025. This looks pessimistic and too late, given the broader economic trends still unfolding, and despite the slight upside surprise in April. Inflation is on track to head towards 3 per cent a year earlier than this forecast.
Will the interest rate hikes end?
The RBA board meets next week and, after the extraordinary and shocking interest rate hike at its May meeting, a further rate rise cannot be ruled out. But if its focus is on broader growth trends, the labour market and the realistic outlook for inflation, it will remain on hold.
After all, there are 375 basis points of interest rate hikes in the system and these are yet to fully impact on growth and inflation. There is more downside ahead. A pause in June and a strategy to revisit the inflation outlook in July would be prudent, rather than hiking interest rates excessively when the economy is already weak.
Australia does not need nor, indeed, want a recession. With each interest rate hike, the RBA is risking such an outcome.
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