The economy’s 3.4 per cent rebound in the last three months of 2021 confirms the consumer-led recovery from lockdowns. Russia’s invasion of Ukraine may hit the global recovery just as the Queensland floods will hurt Australian GDP in the March quarter. But because Australia is a net exporter of energy, higher oil and gas prices will produce an offsetting external boost to national income GDP. And both new shocks will add to the inflation pressure already bubbling up from the pandemic.
The future remains uncertain. But it’s hard to see how underlying inflation – which already has been within the RBA’s 2-3 per cent target band for the second half of 2021 – will fall below target over the rest of 2022 and into 2023. The 4.2 jobless rate is the lowest in 14 years and surely is close to the level where labour market inflation pressures emerge. Yet, with businesses struggling to find workers, the central bank’s cash rate is being held at extreme emergency settings of 0.1 per cent. That’s a negative real interest rate of at least 2 per cent.
With US inflation accelerating to 7 per cent amid the COVID-19 global supply chain disruptions, governor Philip Lowe last month walked back his extreme “forward guidance” that the cash rate would stay nailed to the floor until 2024, admitting that a rate rise in 2022 was a “plausible scenario”.
Following Tuesday’s March board meeting that kept the cash rate on hold, Dr Lowe pointed, not unreasonably in itself, to the war in Ukraine “as a major new source of uncertainty”. He further pointed out that it’s unclear how much of the Ukraine war related spike in the global oil price to over $US100 a barrel will feed into Australia’s petrol pumps and hence into CPI inflation.
Yet the central bank’s worry that inflation may undershoot its 2-3 per cent target seems incredible. The Reserve Bank agrees that consumer spending has picked up as the omicron wave recedes; household and business balance sheets are still juiced up with saved fiscal stimulus; there is an upswing in business investment; and a large pipeline of infrastructure projects in the works. Money markets have pushed up three-year and 10-year government bond yields. And traders are still pricing in four Reserve Bank cash rate hikes this year to lift the cash rate just above 1 per cent. Even then, the central bank’s monetary policy interest rate would still be negative in real or after-inflation terms.
The RBA’s “patient” caveat on lifting interest rates reflects the vague full employment mandate of its Keynesian-era charter – at a time when just about everyone who wants a job now has one – and Australia’s stubbornly “modest” growth in wages and labour costs. Putting a 3 in front of unemployment would be a historic and worthwhile achievement. Yet perhaps not everything that’s desirable is plausible at once.
Monetary policy is already way behind the inflation curve.
Allowing inflation to get out of control would jeopardise full employment, and make real wage growth harder to achieve. In any case, monetary policy is already way behind the inflation curve just as Canberra’s fiscal policy needs to start genuine budget repair now. The ultra-low cash rate is a long way from where it would need to be to fight a genuine outbreak of above-target inflation.
Cheap money pumps up asset prices, distorts capital flows, and increases financial risk. Like fiscal policy maxed out by debt-funded pandemic stimulus, monetary stimulus has been pushed beyond useful limits. Sustained prosperity creating high-paying jobs in thriving enterprises now requires the full-blooded structural tax and workplace reforms that neither Labor nor the Coalition will back in an election year.
Along with the market reaction, another uncertainty – be it plague, fires or now floods, war, and oil shocks – can always be found for another interest rate “put”. Or for putting off fiscal repair by pouring more stimulus into the punchbowl as the March 29 federal budget nears. The certainty needed now is confidence that the central bank and the federal government will lean into normalising Australia’s macro-policy foundations and not risk letting both inflation and public debt get out of control.
Source: Financial Review