RBA’s Sarah Hunter watching China stimulus, household spends

The spending patterns of China and Aussie households over the next few months could be key to informing good monetary policymaking, a key RBA official says.

RBA Assistant Governor (Economic) Dr Sarah Hunter says all scenarios are being analysed. Picture: John Appleyard

The Reserve Bank’s chief economist has outlined how stronger or weaker-than-expected demand in the Australian economy could affect the outlook for inflation and lead the central bank to consider higher or lower interest rates relative to its assumption of a downward path for the cash rate target.

In her speech at the University of Adelaide on the role of scenario analysis in forecasting and policy making, RBA assistant governor, economic group, Sarah Hunter showed how higher-than- expected Chinese fiscal spending could lead to higher-than-expected economic growth in Australia.

She also reiterated that the impact of the Stage Three tax cuts on household spending in the coming years is a “key uncertainty” that the RBA has been considering recently.

It comes as the RBA board pivots away from warning about the possibility of higher interest rates as it’s “gaining some confidence that inflation is moving sustainably towards target”.

But stronger than expected jobs data on Thursday pushed back on talk of a February rate cut.

To illustrate the “sort of scenarios we might look at to map from risks to possible policy responses”, Ms Hunter produced graphs of “hypothetical policy responses to illustrative scenarios where demand and therefore inflation are stronger or weaker than a base profile.”

“In the upside scenario the board may need to consider a tighter policy stance – this could be a rate hike or a longer period on hold,” she said. “In the downside scenario, the board may need to consider a looser stance – for example, by bringing forward rate cuts.”

“The board has consistently communicated that it is aiming to return inflation to the midpoint of the target band (2.5 per cent) in a timely manner while retaining as many of the gains in the labour market as possible,” Ms Hunter said.

“The two cases considered here do not achieve these outcomes.

“That is, they would not bring the economy back into balance in the second half of 2026; in the strong-demand scenario, inflation would remain above 2.5 per cent, while in the weak-demand scenario it would drop below 2.5 per cent by the end of the forecast horizon.”

In terms of the domestic economy, she said the impact on consumer demand from household income growth caused by the Stage Three tax cuts was “a key uncertainty.”

“Household real income is currently being lifted by the Stage Three tax cuts taking effect,” she said. “But we cannot be certain how consumers will react to this lift in income.”

By using scenario analysis, the bank aimed to see how the different responses might play out and how material this would be for the labour market and inflation.

“The alternative plausible paths for consumption and the savings rate led to noticeably different paths for inflation and unemployment that would have consequences for policy setting.

“With this in mind, RBA staff are closely monitoring actual outturns and assessing their implication for the outlook for the labour market and inflation.

“And the answer to this question is critical to the board, as a move to the scenarios depicted in green or orange may require a change in policy strategy,” she warned.

Ms Hunter also saw many global risks – in both directions – for the Australian economy.

RBA deputy governor Andrew Hauser discussed one of the “key unknowns” on Tuesday.

He talked about the outlook for global trade.

He said the macroeconomic implications for Australia from future global trade policies “may be less obvious than they first appear.”

And Ms Hunter said China’s fiscal policy is “another current example of a material external risk” that could affect Australia’s interest rate outlook.

China is the world’s second-largest economy and Australia’s largest export destination.

“One way we have explored that is to consider the effects of Chinese fiscal spending being higher than expected,” she said. “The scenario we consider is a very large stimulus package, beyond what we have assumed in our current baseline forecast profile.

“It is not an outcome we think is likely to be announced in the near term.

“While here we look at the impact of a stimulus package in isolation, in practice a large stimulus would be most likely if growth prospects in China were to deteriorate for some reason.

“In that case, the impact on the Australian economy would differ from the scenario.”

Assuming CNY4 trillion ($880bn) of extra Chinese fiscal spending versus a CNY2 trillion baseline assumption, along with exchange rate movements and the RBA’s current assumptions for the path of its cash rate target, RBA modelling shows Australia’s economic growth peaking at about 2.7 per cent on an annual basis in 2025 versus its current forecast of about 2.3 per cent.

“The goal of all this work is ultimately to help inform good monetary policymaking,” Ms Hunter said.

“Scenarios allow policymakers to consider how to make their strategy more robust to key risks materialising.

“That might mean choosing a policy strategy that performs well – in terms of inflation and employment outcomes – under a range of possible scenarios, rather than just in the most likely central forecast.”