RBA must hike rates and hope the economy has not hit the wall

RBA governor Phil Lowe and his board really have no option but to hike rates again next Tuesday and then spend June assessing whether the economy has hit the wall.

Is our economy in the process of right now hitting-the-wall, 1990-style?

Or is inflation in the process of becoming entrenched in the 5-6 per cent level?

Or – what would really keep both you and Reserve Bank governor Philip Lowe, alike, awake at night - both?

These are the absolutely critical questions right now.

And they are backdropped by an even more ominous question: is the fabulous China growth story in the process of finally imploding and, quite simply, ending?

Since China abandoned its zero-Covid policy, its strong rebound growth and surging demand for our iron ore, coal, and gas has been the absolute foundation of the ‘good news’ in and for the Aussie economy.

That was captured by the claimed budget surplus. But for China the federal budget would have looked like Victoria’s.

But now, both – what is laughably called - the data and the anecdotal evidence out of China, says the post-Covid boom is running, at best, flat; but worse, maybe all the structural problems that have built up over the last 15-20 years are bubbling to the surface.

Our colleague Robert Gottliebsen lays out a very persuasive case for the ‘hitting-the-wall’ reality in The Australian. I commend you read it – indeed, many of you might well be experiencing it.

In summary Gottliebsen points to a dramatic and sudden fall in consumer spending joining with a slump in home building approvals.

In the most basic way it really should be obvious: inflation has been running at 7 per cent-plus, yet wages have only been growing at 3-4 per cent.

RBA governor Philip Lowe. Picture: NCA NewsWire / Gary Ramage

Plus, home-loan borrowers have been hit with 3.75 percentage points of rate hikes.

Obviously, their ability to spend will have been slashed. And that’s before accounting the pent-up post-Covid explosion of spending by Australians overseas.

Yet at the same time, Wednesday’s inflation data from the ABS showed inflation staying stickily high around the 6.5 per cent level.

And we are about to see a – thoroughly understandable - surge in wages in both the private and public sectors.

I suggest Governor Lowe is being too sanguine expecting – hoping – that the overall wage index won’t go much above 4 per cent.

To me, the serious risk is that it approaches 5 per cent later this year.

As Lowe explained, yet again, a 4 per cent generalised wage rise across the economy is utterly incompatible with getting inflation down near 3 per cent, given our zero productivity.

So wages growing closer to 5 per cent would mandate further, punishing interest rate hikes.

The core message that Lowe has been articulating is the risk of doing too-little too-late with rate hikes.

That risks having to do more punitive rate hikes and leaving rates at punitive levels for longer.

But that is exactly what he has been doing, clinging desperately to his softly-softly ‘narrow path’.

After the incoherence of the last two decisions – April’s pause and then May’s shock hike – and in the wake of the 6.5 per cent inflation print, he, and his board, really have no option but to hike again next Tuesday.

Then, spend June assessing whether the wall is being hit.

Originally published as RBA must hike rates and hope the economy has not hit the wall