Avoid inflation trap: fresh warning from OECD’s Aussie chief Mathias Cormann

The OECD chief says Australia faces a ‘difficult path’ trying to ensure inflation doesn’t become embedded in the economy.

OECD secretary-general Mathias Cormann.

The head of the OECD says ­Australia faces a “difficult path” ahead in trying to ensure inflation does not become embedded in the economy while the impact of mortgage stress from rising interest rates will need to be carefully monitored.

Mathias Cormann, secretary-general of the Paris-based international body and a former Australian finance minister, told The Australian that while the most aggressive monetary tightening since the 1980s had been warranted, the central bank was right to pause interest rates at its July meeting to assess the impact on the economy and households.

But he also offered a word of caution about the longer-term structural state of the budget, ­saying that while fiscal settings were expected to remain broadly “neutral”, reform should be ­considered “to improve the ­sustainability of public finances, in particular in relation to the NDIS.”

He also urged the federal government to continue to “bank any windfall revenues from high commodity prices to help achieve their fiscal consolidation”.

Mr Cormann, Australia’s longest serving finance minister before being appointed as the secretary-general of the Organisation for Economic Cooperation and Development in 2021, said that, despite fears of recession, economic growth in Australia was still projected to be running ahead or at average for OECD countries and inflation was trending down to be generally in line with the OECD average.

However he noted that corporate tax was still above the average of the 38 OECD member countries, which had implications for Australia’s international competitiveness and its ability to attract foreign investment.

Mr Cormann suggested that global monetary tightening had had a faster and more significant impact on Australian households and businesses compared with those in other economies because of the high percentage of those on variable mortgage rates.

“Australian monetary policy must continue to navigate a difficult path, ensuring that under­lying inflationary pressures do not become embedded while closely monitoring the impact of the past rapid and globally synchronised monetary policy tightening on the real economy,” Mr Cormann said.

“So yes, a restrictive stance of monetary policy remains appropriate until there are clear signs that underlying inflationary pressures are abating.

“The decision to raise rates to 4.1 per cent at the June RBA ­meeting was warranted. It is also ­appropriate to now take the necessary time to monitor the ­impact of past decisions in the data coming through. Considerable uncertainty calls for a data-dependent approach combined with clear ­communication of the monetary policy reaction function.

“In early 2023, around 45 per cent of low-income people with a mortgage were devoting more than one-third of their income to servicing their housing loan.

“There have not been significant signs of stress so far, but, with high and increasing interest rates and declining real incomes, this situation needs to be carefully monitored.”

Mr Cormann said that despite the rapid monetary tightening in Australia, interest rate rises in Australia had been more gradual and rates were still at lower levels than peer OECD countries such as the US, Canada and the UK.

“However, the fact that a relatively high share of the outstanding loan stock in Australia is on variable interest rates means a faster and more significant impact of changes in the official policy rate on household and business balance sheets,” he said.

Mr Cormann said Australia’s core inflation was broadly in line with the average across the 38 OECD member countries.

Most recent data on core inflation in Australia was broadly in line with the average across the OECD. Consumer Price Inflation (excluding volatile items) was 7.3 per cent year-on-year in Australia in the first quarter of 2023 compared with 7.1 per cent on average in the OECD.

But Mr Cormann noted there had been a continued trend downwards with the monthly headline figure for the 12 months to April at 6.8 per cent and to May at 5.6 per cent.

While the government has banked a bigger than expected surplus for this year, Mr Cormann noted there were longer-term issues with forecasts for a return to a deficit that widens over the forward estimates.

“Further fiscal reforms should be considered to improve the sustainability of public finances, in particular in relation to the NDIS,” he said.

However, he said Australia was well placed compared with other nations to weather the global downturn, with tax revenues and debt as a share of GDP lower than the OECD average while the structural deficit was comparatively moderate.

“Australia has very healthy macroeconomic fundamentals: growth prospects are quite favourable, and the unemployment rate is low,” Mr Cormann said.

“This is in part linked to a key natural advantage Australia has, the fact that it is a major exporter of commodities the world needs. This has helped to insulate the Australian economy from commodity price shocks experienced in other advanced economies.

“In particular in the context of the economic impact, including the significant increases in the cost of energy, fertilisers and food, caused by Russia’s war of aggression against Ukraine, Australia has, on balance, been a beneficiary with significant increases in its terms of trade.

“At the same time though, it also means, as always, that Australia’s economic performance is exposed to volatility and impacted very directly by the performance of its major trading partners.”

Mr Cormann said it was expected that higher interest rates and cost-of-living pressures would dampen spending by households with fewer accumulated savings.

“Past falls in house prices will cause a further drag on consumption through their effect on household wealth, and together with tight financial conditions will continue to weigh on housing investment,” he said. “But high global commodity prices have boosted Australian export earnings, which has helped Australia weather the downturn so far.

“We also expect continued strong population growth and higher services exports, in particular as international travel continues to recover to at least partly offset the current headwinds.”

He said there were still risks associated with Australia’s exposure to global conditions, including commodity prices.

“We also expect that Australia will benefit from increased demand for critical minerals like cobalt, lithium and rare earths as well as nickel, all essential for the transition to cleaner energy,” he said.