RBA’s in a quandary about what to do next

Reserve Bank of Australia governor Michele Bullock. Picture: Jeremy Piper

The fog blanketing Australia’s economic outlook has thickened, leaving the country’s central bank in a quandary about which direction to next take interest rates.

The best course of action for the Reserve Bank might be simply to do nothing until the haze dissipates. But that will take time, leaving interest rates high for longer than needed, ramping up the risk the RBA gets it wrong.

One side of the risk equation is the possibility that policy stays too tight for too long, bringing on a recession that destroys large numbers of jobs and businesses.

On the other side is the prospect that policy loosens too quickly, allowing elevated inflation to become entrenched, crunching real wages. The RBA is attempting to stay on a narrow path that separates both of these scenarios. It’s getting harder to see.

Higher-than-expected first quarter inflation data last week has unsettled the central bank, with the critical conversation at its policy meeting next week set to focus on the question of whether or not disinflation has stalled. It’s a discussion the RBA was confident it wouldn’t have to return to after it moved its narrative closer to neutral over recent months.

But with inflation in the first quarter still annualising at close to 4 per cent, well above the target of 2 to 3 per cent, the RBA’s board will sit down next week to unpack the data still showing price pressures remain frustratingly hot.

The RBA was always prepared for the fact that the last battles of the war against inflation would be hard fought. But the consumer price index is tracking above the forecasts it published in February and discomfort has returned.

A tipping point for the board to bring a rate hike back into the discussion might not be far off. Policy makers will be watching the budget for 2024-25 on May 14 given that it is likely to include new spending aimed at easing rising living costs while also bolstering the Labor government’s hopes of re-election. Added stimulus from Canberra will do nothing to help bring down inflation.

A decision on how far to boost the minimum wage is also due soon, while income tax cuts are already locked in for mid-year.

With population growth surging, there remains a good deal of demand left in the economy even after the biggest rise in interest rates since the 1980s.

The RBA is also looking over its shoulder at the US, with the Federal Reserve expected to back away further from rate cuts at a policy meeting this week following successive upside shocks on inflation reads. “The RBA were late to start hiking, and have not hiked as high as other major central banks, so expecting them to start cutting early was always odd from our point of view,” said Craig Vardy, head of fixed income at Blackrock. “The most painless remedy for a central banker is a higher for longer cash rate.”

Dow Jones Newswires