After her rhetoric about not cutting interest rates this year, RBA Governor Michele Bullock will have her credibility on the line if she doesn’t cut on Tuesday. Michael Pascoe reports the RBA’s hawkishness is suddenly looking very lonely.
Wednesday’s inflation figure – never mind the 2.8 % CPI, the trimmed mean rose 0.8 % in the September quarter to make 3.5 for the year – has dramatically changed the outlook for interest rate cuts. Yes, the Reserve Bank needs to cut and cut now.
Yet the RBA leadership – lacking experience in taking the big step of changing policy direction – will have its nerve, pride and courage tested next week in coming to terms with the change.
The bank will have to overcome its months of persistent handwringing about “sticky” inflation, its prioritisation of talking tough and carrying a big stick to maintain “anchored” market expectations of low inflation. In short, Michele Bullock is in danger of doing a Phil Lowe in reverse – being trapped by past statements when circumstances change.
Of course there are the usual pet shop galahs screeching that core inflation is still too high (3.5%! The sky is falling!) and that rates must not be cut. There will even be the odd one or two wanting an increase.
But that’s not how the professionals who actual deal with monetary policy see it. It’s not how just about every other major central bank operates.
Safety in numbers
A thing about central bankers is that they tend to like safety in numbers, they feel uneasy if they find themselves at odds with their peers for long. We’ve even had the Treasury’s inquiry designed to make our RBA more like the others.
“The others” – the US Federal Reserve, the European Central Bank, the Bank of England, the Bank of Canada, even the RBNZ – have already been where the RBA is now.
All of them started cutting rates well before inflation had reached their targets.
All of them understood the lagged nature of monetary policy.
All of them wanted to avoid causing a recession.
In fact, they all changed direction and started easing rates when their inflation was much further above their targets than where the RBA’s is now.
An economist friend, former Reserve Banker Frank Campbell, has done the research to compare the trigger moments for central bank easing and has shared his homework.
Assuming the RBA has the courage to do the right thing on Tuesday and does not feel trapped by Michele Bullocks’ forward guidance that she says isn’t forward guidance, it will trim its cash rate by 25 points to 4.1 per cent when its measure of core inflation is 0.5 above the top of its two-to-three per cent target range.
The preemptive strikes
When the US Fed (in September), the ECB and the Bank of Canada (both June) first cut rates, they all had inflation 0.7 above their targets.
When the Bank of England first cut in August, inflation was 1.5 above target. The RBNZ, also August, was a whopping 1.6 above.
Not only that, all of those central banks were further away from their forecast date of inflation hitting target than the RBA is now. When they cut, the Fed, ECB, BoE and RBNZ weren’t expecting to hit target until 2026.
The RBA’s August set of forecasts predicted hitting the top of the core inflation range in the second half of next year.
Hawks, doves, penguins and a shag
The monetary aviary keeps expanding beyond hawks tightening, doves loosening and emperor penguins sitting pat. Rather than being seen as a monetary hawk if it doesn’t cut rates on Tuesday, the RBA will appear as a lonely shag on its monetary rock.
Worse than appearances, the RBA will be in danger of causing more serious damage to the Australian economy and those who sail in it, especially those bailing hard to keep their heads above water.
Treasury’s RBA Inquiry recommended the bank communicate more, resulting in an investment in more PR staff. A Chief Communications Officer now sits in on board meetings.
For those with a career in spinning, tailoring the necessary change of policy on Tuesday also might be a challenge. It would be a gormless PR play to hold off biting the bullet until December for the sake of being seen to phase in the change. Delaying to see the September quarter GDP number on December 4 would be a meaningless fudge.
They will say …
The wannabe hawks might argue that being 0.5 above the top of the target range isn’t enough. The new agreement with the Treasurer oddly added “the midpoint of the range” – 2.5 % – as something the bank should tend towards, but the actual target remains the range, not the midpoint, as December’s Statement of Monetary Policy makes explicit:
The Reserve Bank Board and the Government agree that a flexible inflation target is the appropriate framework for achieving price stability, recognising the importance of low and stable inflation. They agree that an appropriate goal is consumer price inflation between 2 and 3 per cent. This approach supports the anchoring of inflation expectations, while recognising that all outcomes within the target range are consistent with the Reserve Bank Board’s price stability objective. The Reserve Bank Board sets monetary policy such that inflation is expected to return to the midpoint of the target. The appropriate timeframe for this depends on economic circumstances and should, where necessary, balance the price stability and full employment objectives of monetary policy.
Which brings up the mystery of “full employment” – the new regime’s euphemism for the old NAIRU (non-accelerating inflation rate of unemployment).
Forget the euphemism. The RBA has never known what the NAIRU is until it sailed past it. It’s a figure only seen in the rear vision mirror.
The story of recent years is one of the econocrats being consistently wrong about the NAIRU and having to steadily reduce their guess as unemployment fell. Most recently, the RBA has reckoned 4.4 per cent – but it simply does not know.
Labour market strong
Yes, the labour market is strong, employment growth is strong – and they are good things that are not pushing up inflation. Unemployment is steady at 4.1 per cent with inflation heading in the right direction. This should all be seen as positive news.
Economist and former Gillard government adviser Stephen Koukoulas argues that something is not computing about our labour market. It is a contradiction to have good employment growth and such weak economic growth.
“Which is accurate?” he asks. “The measures and estimates of GDP or the labour force with employment and unemployment?
“The simple answer is both could be correct — or that we don’t yet know.
“Australia has also seen the boom in job creation coincide with clear signs of moderating wage growth – again, something that rarely if ever happens in any sustained way.
“And this with a government-inspired lift in wages in a few essential services – as well as chunky increases in minimum wage awards by the Fair Work Commission (FWC) – rather than a strict demand driving wages surge.
“Wages growth would be materially lower without these interventions.”
The RBA is only fooling itself if it pretends to know what NAIRU is even while pushing to take unemployment higher. A paragraph in an earlier Statement on Monetary Policy this year admitted it could start with a 3 – a possibility not a probability, according to the RBA.
Inflation is trending down
What the bank’s board should know is that inflation is trending down, is on track to hit the target and monetary policy works with a long lag – the tightening flowing through from the last rate increase still isn’t complete.
What the bank’s board should know is that inflation is trending down, is on track to hit the target and monetary policy works with a long lag – the tightening flowing through from the last rate increase still isn’t complete.
The quarterly CPI numbers carry the most weight, but the story of the last three ABS monthly inflation counts show the year-to trimmed mean trending down from 3.8 to 3.4 to 3.2 per cent.
Yes, the services inflation component is sticky, but it’s been sticky everywhere and “services inflation” isn’t what the bank is mandated to massage – it’s the overall number. Besides, interest rates have little impact on the key elements of service inflation – rents, insurance and medical expenses.
The RBA shouldn’t want to be caught out like a shag on a rock. Do it, cut the cash rate. And don’t worry about the facile matter of being accused of misleading the market in the lead up.
Michael Pascoe is an independent journalist and commentator with five decades of experience here and abroad in print, broadcast and online journalism. His book, The Summertime of Our Dreams, is published by Ultimo Press.