Australia’s economy is on track for a soft landing as RBA governor Philip Lowe prepares to exit

Departing RBA governor Philip Lowe. Picture: AFP

As Philip Lowe prepares to leave his job as the governor of the Reserve Bank of Australia next month, it is increasingly likely he will do so knowing that after a rapid tightening of the interest-rate screws, the economy is steering with greater certainty toward a soft landing.

For the first time in more than a year, the RBA left interest rates on hold for a second straight month and indicated its growing confidence that the supply and demand imbalances that drove inflation to its highest level in over three decades are now correcting.

“The higher interest rates are working to establish a more sustainable balance between supply and demand in the economy and will continue to do so,” Dr Lowe said on Tuesday as he announced the decision to keep interest rates on hold.

Inflation cooled by more than the RBA expected in the second quarter, giving the central bank the assurance it needed to stay on the sidelines again this month and not add to the misery of home buyers who have been hit by a record 400 basis points of interest-rate increases in the past year.

What is unusual about the rapid easing of inflation pressures is that it is happening against a backdrop of unemployment stubbornly remaining at its lowest levels in about 50 years.

Historically, an unemployment rate of 3.5 per cent in Australia would trigger a wage surge sufficient to keep inflation fires burning bright for years.

But that hasn’t been the case. And while that is happening, an economic soft landing – where growth slows but doesn’t collapse and unemployment rises only a little over time – is more likely to play out.

Suppose this Goldilocks scenario remains the dominant narrative for the economy over the coming months. In that case, the RBA may only need to tweak the setting of interest rates from here – or it could remain permanently on the sidelines.

Other things are running in Australia’s favor, including surging population growth.

With international borders reopening after the pandemic years, net immigration is running at about 400,000 a year, close to twice what was expected, adding to demand in the economy.

And with interest rates back at their highest level since 2012, the RBA again has the firepower it needs to support the economy should economic growth slow alarmingly.

Employment growth is at a robust 3.0 per cent, with full-time employees making up the bulk of the hires, while the number of hours people work is also rising.

The job market’s strength is also visible in the number of unemployed workers for each job vacancy, which is at 1.2 compared with the pre-pandemic level of about 3.0.

And while household budgets are under extreme stress as interest rates rise, household balance sheets have found support in solid income growth, and the latest data suggests loan impairment rates remain historically low.

House prices have also been rising for the past five months, suggesting that there are reserves of cash in the economy seeking an investment home.

Still, there are clear risks to achieving a soft landing.

Big increases in prices of electricity, health insurance, the minimum wage and rents could put a floor under the downward drift in inflation between now and the end of the year, prompting the RBA to consider more drastic action on interest rates.

The RBA might also worry that the low unemployment will eventually convert to higher wage growth, delaying inflation’s return to target.

For now, there is plenty of scope to think a deep and scarring recession can be avoided.