RBA faces ‘last chance’ to stamp out inflation for good, says Westpac’s Bill Evans

Influential Westpac chief economist Bill Evans reckons the Reserve Bank of Australia is facing its ‘now or never’ moment to get inflation back under control.

Influential Bill Evans reckons the Reserve Bank of Australia is facing its “now or never” moment to get inflation under control or risk rates surging to near 1990s levels. This is why households should brace for more hikes to come even with signs the economy is fast cooling.

Evans, who is closely watched by money markets given his long track record of accurate calls, says the central bank on Tuesday afternoon will push through its 10th rate hike in as many months. Significantly, he says it’s still too early for the RBA to start talking about coming to the end of its rate hiking cycle with annual inflation running at 7.4 per cent.

Evans was speaking at a Westpac customer event on Monday and the veteran economist didn’t hold back.

“They (the RBA) still realise that the bigger cost is to be caught sleeping at the wheel and let inflation get away,” Evans says. “ And then you’ll have to go a lot harder as we had to do in the 90s. I think they will err on the side of making sure that maybe they will overreach.”

Evans, like most of the market, is pencilling in another 25 basis point hike on Tuesday, taking the cash rate to 3.6 per cent. He expects another hike in April.

The hawkish shift follows too many mixed messages coming from the RBA last year. Indeed, the central bank was “wishy-washy” on rates, at one point suggesting it would pause even as inflation was getting away. Now the bank needs to hold its nerve despite rising political slings it is tanking the economy.

“You’ve got to make sure you stay the course on the rates,” Evans says.

In the past two weeks Evans upped his estimate of peak cash rate to 4.1 per cent, which should come by the middle of this year. While this was a shift from Westpac’s previous longstanding forecast of 3.85 per cent, Evans had been well above the market, making him one of the few economists early in the inflation cycle to take the view that rates would be higher than many believed.

However, at 4.1 per cent, the cash rate will be getting closer to the real pain zone for households and businesses. This will mean a “stagnant economy” for the second half of this year, Evans cautions. Although as the economy slows inflation should come back, then the RBA can reverse course through 2024.

Australia’s economy is expected to slow sharply this year. Picture: NCA NewsWire / Brendan Read

It’s a narrow path and a lot needs to go right for Australia to have a textbook lancing of the inflation bubble. Softening the blow will be exports. China, which ranks as Australia’s biggest trading partner, is targeting 5 per cent growth this calendar year, which represents a recovery for the giant economy from the tough Covid lockdowns of 2023.

Inflation appears to have peaked in Australia, Evans says, but it’s just not falling as quick as in other major economies.

Evans voiced criticism of RBA governor Philip Lowe, although not over the call in the early months of the pandemic that rates would stay at rock bottom levels for years to come. Evans defends that forward guidance, arguing it was important in turning around the economy and getting the housing market firing.

Where mistakes were made was the RBA missing the implications of the Covid-19 vaccine rollout. It then doubled-down on its quantitative easing efforts and pushed the forward guidance out to 2024 as other central banks were preparing to wind back stimulus. “I think they were slow to respond to that game changer,” Evans says.

With Australia expected to skirt a recession, with growth slowing to just 1 per cent, this will certainly feel different to what we experienced in the early 1990s. Then, Evans points out, unemployment and interest rates climbed to double digits while the commercial property market was moribund. Banks, including Evans’ own, were groaning under the weight of lending losses.

This time around Evans expects unemployment to climb to between 5.25 and 5.5 per cent. It’s a shock to hear such an unemployment rate while it has been plumbing near record lows and is currently at 3.7 per cent. However it is easy to forget it was stuck in the low 5 per cent range for years before Covid-19 hit.

He also points out that the 1990s recession was exacerbated by a number of missteps by policy makers. Then Canberra was slow to respond to a deteriorating economy with fiscal measures. At the same time the central bank was looking to reel in the ballooning balance of payments deficit.

“Now it’s much more sensible, they’re targeting inflation. The slowing down of inflation is already under way and we can start to see how that’s going to evolve. If you look at inflation at the moment at 7.8 per cent for the last year and about a third of it was what I would call services, which is demand driven.

“Two-thirds of it was related to goods, supply chains, and the shocks from the war. Now, we could see those unravelling as we go through this year. I’m pretty confident that by the end of this year, inflation will be down to around 4 per cent,” Evans says.

One area where Evans splits from economic purists is around fiscal relief measures for cost of living in the May budget. While there are fears this could lead to fiscal and monetary policies pulling in different directions and adding to inflation, Evans reckons there’s a real argument for targeted support for those doing it tough. Here he points to the lower middle income tax offset program scheduled to expire at the end of June, a move that will effectively take $7.5bn out of the economy. The RBA will be able to manage the inflation story using the brute force of the cash rate.

“These are the sorts of issues that I think fiscal policy has a role to play in the budget. And I suspect that the government will see that so I’m certainly not going to be crying from the rooftops that ‘you should not be providing targeted support for this economy’, because it’s going to be a very tough time for some.”

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Originally published as RBA faces ‘last chance’ to stamp out inflation for good, says Westpac’s Bill Evans