In Australia, the Reserve Bank’s actions seem increasingly out of sync with emerging economic conditions. This is raising questions about its monetary policy strategy, as it maintains an unusually high interest rate despite achieving its inflation target.
The Inflation Target: Achieved, Yet Rates Remain High
The Reserve Bank’s mandate requires it to aim for a 2-3% annual inflation rate. Following rapid rises, inflation fell to 2.8% this past week, landing within its target range for the first time in two years. This shift occurred just ahead of the Reserve Bank’s upcoming board meeting, where it will determine whether to adjust the cash rate. However, Michele Bullock, the current governor, has hinted that a rate cut is unlikely, even as inflation falls.
The bank raised the cash rate to 4.35% through 13 rapid hikes between May 2022 and November 2023. This aggressive approach aimed to counter some of the highest price pressures in decades. However, it also pushed mortgage rates from 2.6% to 6.1%, adding over $1,000 to the monthly payments for a $600,000 loan.
Bullock has noted that rate reductions are unlikely in the next six months. Yet former Reserve Bank governor Bernie Fraser criticizes this approach, arguing it conflicts with the bank’s role. “The bank’s job is to make judgments based on what it can foresee,” Fraser says. He believes the Reserve Bank should avoid overly committing to forecasts.
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Economic Tactics: Messaging vs. Market Influence
The Reserve Bank’s officials have historically used “open mouth operations” to influence consumer behavior through communication. Previously, Bullock’s predecessor, Philip Lowe, hinted that cash rates would remain low until 2024, aiming to spur spending. However, rising inflation worldwide led Lowe to raise rates sooner than anticipated.
Bullock’s approach is more conservative. She is working to temper consumer expectations, suggesting rates won’t fall to prevent premature spending that could reignite inflation. However, she may adjust her messaging when conditions warrant a rate reduction.
Inflation Fall Partly Due to Temporary Policy Measures
Inflation’s recent decline owes partly to one-time rebates. Temporary electricity rebates in Queensland, Tasmania, and Western Australia led to a 17.3% drop in electricity costs, contributing significantly to lower inflation. Without these rebates, electricity prices would have remained stable.
Meanwhile, an increase in Commonwealth Rent Assistance reduced recorded rent inflation from 8.5% to 6.7%. Shadow Treasurer Angus Taylor has labeled these budget measures a “trick,” suggesting they don’t fundamentally change the Reserve Bank’s inflation stance. But these measures help shape Australians’ perception of inflation, which may reduce future inflation pressures.
In monthly surveys, the Melbourne Institute found Australians now expect an average 2.5% inflation rate, well within the Reserve Bank’s target. This expectation indicates that people believe high inflation has ended, signaling a return to stability.
The Broader Impact of Low Inflation
Recent budget measures targeting electricity and rent costs have set the stage for broader inflation declines. Lower recorded inflation reduces price increases tied to contracts, including the consumer price index (CPI), which is the benchmark for student debt, family tax benefits, and unemployment payments. The Reserve Bank’s “trimmed mean” measure of inflation, which filters extreme price changes, fell to 3.5% from 4% over the September quarter. This trend is faster than anticipated, as the bank initially expected 3.5% inflation by December.
Price Divergence: Goods vs. Services
While goods prices fell to a 1.4% inflation rate, services inflation remains “sticky” at 4.6%. This divergence supports the Reserve Bank’s position to delay rate cuts. Bullock is expected to address this argument at the next board meeting, reinforcing the case against rate reductions.
A Path Forward: Economists Signal Future Rate Cuts
Despite current interest rates, former Reserve Bank chief economist Luci Ellis suggests that a cut is approaching. While she doesn’t expect this decision in December, a reduction in February 2025 appears likely. Ellis highlights strong employment as a factor delaying cuts, though Fraser predicts job numbers could weaken soon. He notes increasing layoffs and closures among small businesses, signaling potential economic strain.
Fraser draws on his experience, noting he implemented rate cuts early to curb the 1990s recession. He believes the Reserve Bank should lower rates early, like a driver braking before reaching a stop. Cutting too late could harm economic growth, especially with upcoming federal elections.
The Election Factor: Historic Trends
As federal elections approach, Fraser and other experts see a potential rate cut ahead of the polls. Historically, the Reserve Bank has adjusted rates before elections, acting in 2007, 2013, and 2022. This trend follows a stance outlined by former governor Glenn Stevens, who in 2007 dismissed the idea of delaying rate changes due to election timing. He argued the Reserve Bank must remain independent, adjusting rates as needed to meet economic conditions.
The Reserve Bank’s recent decisions show the difficult balance between policy and perception. The coming months may offer new clarity as inflation stabilizes and pressure mounts to support growth, particularly as Australians prepare to head to the polls.
