Reserve Bank risks recession with August rate rise

The Reserve Bank risks tipping Australia into a recession if it makes a “knee-jerk” reaction to potentially higher-than-expected inflation at its August meeting, economists warn, as households continue to struggle with rising cost-of-living pressures.

If it weren’t for the federal government’s stage 3 tax cuts, a new Deloitte Access Economics report argues, the economy would already be on its way to a recession within the next 12 months, regardless of the central bank’s future moves.

The Reserve Bank board faces one of its toughest choices in recent years at its August meeting.Credit: Louie Douvis

The Australian Bureau of Statistics will publish the June quarter inflation figures next week, the key data release before the RBA board’s next meeting on August 5 and 6.

Deloitte said the economy is at a fork in the road: down one road, higher-than-expected inflation could force the central bank to lift the cash rate from its current 12-year high of 4.35 per cent; down the other, Deloitte said, “more benign” inflation figures would allow the bank to keep rates steady and keep Australia on the narrow path of low unemployment and economic recovery.

The combination of high inflation and interest rates has virtually stalled economic growth: the economy grew by just 0.1 per cent in the first three months of the year, taking annual growth to 1.1 per cent. Deloitte expects the economy to slow further, growing by 1 per cent through the whole of 2024.

Deloitte Access Economics chief economist Pradeep Philip said this would be one of the trickiest central bank board meetings since inflation first took off in 2021.

“Our biggest worry is that a knee-jerk reaction on inflation with higher interest rates will cripple the cautious recovery that is under way,” Philip said.

The RBA board and bank governor Michele Bullock have repeated their determination to bring inflation into the target 2-3 per cent band while keeping unemployment low.

Inflation was 3.6 per cent in the year to March and is expected to rise slightly to 3.8 per cent in the year to June, while the labour market has remained strong with the unemployment rate, currently 4.1 per cent, well below pre-pandemic levels.

Philip said the Reserve Bank faced a critical juncture.

“What is inflation at 3.5 per cent for a bit longer versus much higher unemployment and recession? That’s the trade-off,” he said.

“We don’t think the bank will raise rates, and we don’t think they should raise rates.”

Krishna Bhimavarapu, Asia Pacific economist for Investment management firm State Street Global Advisors, also believed an August rate rise would be a mistake.

Bhimavarapu said there were signs the labour market was cooling, household spending was weak, and there was a chance inflation could reach the Reserve Bank’s target range of 2–3 per cent this year.

“The economy is at a tipping point, where the unemployment rate could rise beyond [the RBA’s] comfort level,” Bhimavarapu said.

“Any further hiking could exacerbate the situation and tip the economy into recession.”

The Deloitte report pointed to New Zealand as a warning case. The country had a similar pandemic response and economic structure, but its central bank raised rates far higher than Australia’s – the New Zealand cash rate is 5.5 per cent.

That economy has spent the past 18 months dipping in and out of a technical recession, and the unemployment rate in New Zealand has gone from being well below Australia’s rate to above – at 4.3 per cent.

Philip said the kicker was inflation there has not been tamed more quickly than in Australia, and there were lessons there for the RBA.

One lesson was understanding the drivers of inflation – which Deloitte does not believe are issues of demand outstripping supply at this point.

“The economy’s not overheating, which is the main reason you use the instrument of interest rates to curb inflation,” Philip said.

“The household and consumer side of the economy has been struggling for quite a while, buffeted by inflation, higher interest rates, and what’s driving these things? Things like higher mortgage repayments, soaring rents.”

However, the Deloitte report said stage 3 tax cuts will buoy household spending over the coming months.

“If it wasn’t for fiscal policy, the economy might be in recession in the coming year,” it said.

Treasurer Jim Chalmers said the report confirmed that the government’s economic plan was responsible and that households would be in even more trouble if not for Labor’s management.

“We are realistic about the challenges facing our economy, including the global uncertainty, geopolitical tensions and softer growth detailed in these forecasts,” he said.

“We understand people are under pressure, which is why we’re delivering substantial and meaningful cost-of-living relief in the most responsible way we can.”

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