Why the RBA is highly unlikely to lift interest rates next week, even if inflation climbs
- Written by Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University
The inflation figure due to be released to is different than most. It’s focusing the minds of politicians as well as economists.
Inflation has been falling for the past five quarters, getting closer and closer to the Reserve Bank’s target band.
At the last quarterly read, three months ago, it wasn’t far away. Inflation came in at 3.6%[1], well down from the peak of 7.8%[2], and within sight of the 2-3%[3] band.
There had been talk about a cut in interest rates[4], soon. It’s a good idea to ease rates before inflation is actually in the band, for the same reason it’s a good idea to ease off on the accelerator and tap on the brakes before you want to stop a car: changes in interest rates affect things with a lag[5].
Now there are forecasts that the figure out on Wednesday will show inflation has gone up, perhaps to 3.8%[6], perhaps to 3.9%[7], or perhaps to 4% or more.
What has politicians transfixed is the possibility that the Reserve Bank of Australia (RBA) will conclude that progress on inflation has stalled and it needs to push up interest rates at least one more time to make sure inflation heads back down.
The bank could do that after its board meeting on Tuesday next week[8], when it publishes its quarterly statement on where the economy is heading.
Will we see another pre-election rate hike?
A rate hike in what’s now the lead-up to next year’s election might do to the Albanese government what a rate hike before the last election did to the Morrison government – it helped push them out of office.
But I think there’s a good chance the Reserve Bank won’t push up rates, even if the inflation number is high, for a number of reasons.
One is that the Reserve Bank itself[9] has been forecasting inflation of 3.8% in the year to June. Inflation shot down to 3.6% sooner than it expected in March, and a move back up to 3.8% will return things to where it expected them to be.
What’ll matter more to the bank is what’s driving inflation. Back in June, the bank’s new deputy governor let us in on his thinking about that.
Andrew Hauser took up his position at the Reserve Bank in February, after a career helping set rates at the Bank of England.
He noted that inflation in the price of goods was coming down faster[11] than inflation in the price of services, but said that wasn’t unusual. Across most countries, the pictures looked “incredibly similar[12]”.
It might be that high rates were taking “a little bit longer” to crimp inflation in the prices of services than goods. If so, the right response would be to “hold your nerve” and note that services inflation has been coming down but in a “slightly bumpy way”.
Some prices are beyond the RBA’s control
The other point Hauser was especially keen to make is that the prices of many services are “administered” – that is, set by the government or a tribunal.
The prices of childcare, hospital care, electricity, water, gas and public transport are, to a large extent, administered. They are beyond the scope of the Reserve Bank to influence by moving interest rates.
There was “an interesting question”. Should the Reserve Bank strip out these prices out of the inflation measure it targets, given that it can’t target them, and just target the rest? Or should it push down on the rest “a little bit further” to bring total inflation back to target?
Inflation in other prices is coming down
Hauser spoke as if someone calculated the inflation rate on only the things the Reserve Bank could influence, they would find out it was already very low.
So this week, the ANZ Bank economist Blair Chapman did that[13] – and that’s what he found. Inflation in the prices the Reserve Bank could easily influence was already back within its target band.
Inflation in other prices – in administered prices, or prices automatically indexed to previous inflation – remained above the band, but was coming down.
And Hauser made another point he thought was exceptionally important to him, as a new arrival from the United Kingdom: Australia isn’t the UK[14].
In the UK, the Bank of England’s primary goal is to bring inflation back to target. Everything else is secondary, subject to the overriding goal, including supporting economic growth and employment.
In Australia, there’s a “more balanced objective”.
Full employment has equal weight
Here, the Reserve Bank has two goals[15], neither of which trumps the other.
One is “consumer price inflation between 2% and 3%”.
The other is “sustained and inclusive full employment where everyone who wants a job can find one without searching for too long”.
The Reserve Bank doesn’t have the right to put one ahead of the other.
Australia has chosen to give a greater weight to employment than the UK, and Hauser said “to be honest, so far that strategy has worked”.
The number of jobs that are being created is just enormous. Sometimes you talk about not celebrating success enough; this is an incredible achievement. When you think about adjustments of this scale in the past, they have always involved very, very sharp adjustment in the labour market.
Hauser likes what he sees about Australia. There is “not much to not like here”.
If the price of Australia’s focus on jobs is that “services inflation is taking a bit longer to come down,” he gives the impression he is not too concerned.
When it makes its decision next Tuesday, the Reserve Bank will be concerned not so much with where inflation has been (that’s what this week’s figures will tell us), but where it is going – which is probably down.
And it’ll be concerned with where employment is going, which is probably also down given very weak economic growth[16].
If Wednesday’s figures show inflation alarmingly high, the Reserve Bank will have choice no but to push up rates next week. But otherwise, it’s likely to hold its nerve and watch as inflation continues to decline.
References
- ^ 3.6% (www.abs.gov.au)
- ^ 7.8% (www.abs.gov.au)
- ^ 2-3% (www.rba.gov.au)
- ^ cut in interest rates (www.abc.net.au)
- ^ with a lag (www.rba.gov.au)
- ^ 3.8% (library.westpaciq.com.au)
- ^ 3.9% (d321bl9io865gk.cloudfront.net)
- ^ Tuesday next week (www.rba.gov.au)
- ^ itself (www.rba.gov.au)
- ^ Britta Campion/AAP (photos.aap.com.au)
- ^ faster (www.datawrapper.de)
- ^ incredibly similar (www.rba.gov.au)
- ^ did that (cdn.theconversation.com)
- ^ isn’t the UK (www.rba.gov.au)
- ^ two goals (www.rba.gov.au)
- ^ very weak economic growth (theconversation.com)
