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Australia’s central bank has lifted rates by a total of 2.5 percentage points in its crusade against consumer price inflation. The unprecedented surge in official rates has taken place in just six months—a blink of an eye in monetary policy terms.
Their policy action has coincided with Australian consumer sentiment plunging to recession levels, and a collapse in house prices.
Is it too much?
The market certainly doesn’t think so. Pricing in the market for interest rate futures was at one stage implying a fall in interest rates during 2023, but not any more. Now the market’s best guess is official rates will rise to 4% and hover there during 2023. As the next chart shows, compared to August, market expectations are now lower for the end of this year, but higher for 2023. That would drive up mortgage interest rates, business borrowing rates, etc, crimping demand in the economy at large and helping the RBA achieve its goal of reducing runaway inflation.
The RBA waited a little longer than other central banks to raise rates. Then it unleashed four consecutive plus-size rate hikes, in June, July, August and September this year. In October it changed tack, scaling back its pace of rate hikes from 50 basis points (i.e half of a percentage point) to 25 basis points (i.e. a quarter of a percentage point). That has some people sounding the alarm, accusing the RBA of going soft on inflation. But is that accusation fair?
As the next chart shows, despite the RBA starting to raise rates later than the UK, it has lifted them more.
What is more, Australian inflation is not as high as it is overseas. American inflation is 8.2%, compared to 6.1% in Australia. The US Fed needs to quell inflation by around 6 percentage points to get back to its inflation target of 2%, compared to the RBA’s task of squashing inflation down by around 3 percentage points to reach Australia’s 2-3% target range.
To Err Is Human
A crescendo of voices is rising to say the major risk in the global economy is that interest rates will go too high and cause a recession. The latest is that of Matt King, Citibank investment analyst who warns of “overtightening” causing a recession. His argument echoes that of the World Bank. That institution not only warns central banks might go too far but also identifies why – in previous episodes of inflation, central banks have not been acting in sync. Now they are. As the chart above shows, everyone is hiking rates (except Japan).
You don’t need to paddle as hard if you’re going with the current. If the RBA—or the US Federal Reserve—is using prior episodes of inflation as a guide to how high rates must rise, they may be using a rule of thumb that fails them.
“The cumulative effects of international spillovers from the highly synchronous tightening of monetary and fiscal policies could cause more damage to growth than would be expected from a simple summing of the effects of the policy actions of individual countries in a highly integrated global economy,” wrote World Bank researchers in a paper published in September 2022.
So What Will the RBA Do Next?
A possible clue emerged in recent days in speech by RBA Assistant Governor (Economic) Luci Ellis.
Amid a technical speech concerned largely with measuring and defining the “neutral rate”—the official interest rate at which the economy is neither expanding and contracting—Dr Ellis insisted the market should not expect the RBA to push official interest rates up until they reach that rate.
The neutral interest rate is estimated at roughly 1%, inflation-adjusted. That implies that the “neutral” official interest rate could be 7%, if you take the current 6%CPI figure as the one to use (another option is to use forecast inflation, which is lower). So are rates going to 7%?
“[D]on’t think of this as a mechanistic approach of ‘we have to get back to neutral’, or above neutral. The neutral rate is an important guide rail for thinking about the effect policy might be having. It is not necessarily a prescription for what policy should do,” Dr Ellis said.
That’s arguably a hint from the RBA that they won’t be pushing up rates as far as some market participants think: a welcome sign for those worried the RBA will blindly push the economy into recession in its pursuit of lower inflation.
