RBA’s new grim rates warning

The Reserve Bank board has done a U-turn and is now suggesting productivity could stay weak and interest rates continue to climb and stay higher for longer.

The Reserve Bank has raised the seriously disturbing spectre of Australia sliding into extended stagflation – inflation staying stubbornly high, combined with recession or near-recession – and so interest rates going even higher and staying punishingly higher for longer.

The detailed minutes of the RBA meeting at the start of the month, one week before the budget, which delivered a surprise rate hike, confirmed the RBA really did a U-turn in its thinking at that meeting.

And it was most definitely not a ‘good news’ U-turn.

When the RBA at its April meeting delivered its first rate pause since it started hiking back in May last year, ironically, just before then-Treasurer Josh Frydenberg’s – last – budget, the rhetoric was relatively upbeat in both the decision statement and the subsequent detailed minutes.

The board believed that it was “still possible to navigate the narrow path of bringing inflation down in a timely way while keeping the economy on an even keel”.

The critical sentence in April was “overall, wages growth remained consistent with the inflation target, provided there was some pick-up in productivity growth”.

Yes, to emphasise, the optimism all turned on “some pick-up” in Australia’s abysmal productivity so we could ‘afford’ higher wage increases up to around 4 per cent.

The April minutes made no further reference to productivity; signalling no serious concern within either RBA management or the board that it might not pick up, thereby derailing everything.

Governor of the Reserve Bank of Australia Philip Lowe. Picture: AAP Image/Lukas Coch

This flipped 180-degrees at the May meeting: the minutes suggested serious concern that productivity would stay weak; that it would derail everything.

Weak productivity was referred to a number of times; including, the possibility that “productivity growth remains very weak”.

Critically, to even get inflation back to target as late as mid-2025 – too slowly, in my opinion – assumed “productivity growth returning to around the modest (my emphasis) pace recorded prior to the pandemic”.

I emphasised that because it demonstrates how pathetically low and dangerous productivity is right now; the RBA can’t even be confident of it getting back to a “modest pace”.

Even more extraordinarily, board members discussed “how best to communicate the Board’s decision” – to deliver that, yes, governor, surprise hike. I’ve never seen that before.

And again, the minutes specifically stressed the risks – of inflation staying too high and so interest rates having to as well – including “weak productivity growth”.

Yes, they were also concerned about other things keeping inflation too high, such as sticky services inflation – goods inflation has fallen as supply chains unblock and energy prices ease and stabilise.

But clearly, sustained too-low productivity is the biggest danger of tipping the RBA off its “narrow path”, of gently bringing inflation down without sending both interest rates and the jobless rates sharply and punishingly higher.

That points to the risk of two equally unattractive futures.

One is stagflation – inflation gets stuck around 4-5 per cent, sustained higher interest rates and unemployment; the economy in near or actual extended recession.

Or worse, where the RBA has to really hike, sending the economy into serious recession.

More immediately, it means month-to-month uncertainty on what the RBA does with its rate at every meeting.