Reserve Bank still far from done in tapping policy brakes

Australia’s central bank has slowed the pace of interest rate increases, but it looks likely to continue tapping the monetary policy brakes well into next year.

The Reserve Bank has slowed the pace of interest rate increases, but it looks likely to continue tapping the monetary policy brakes well into next year.

Even with the knowledge that aggressive rate increases will take time to work, the central bank appears to be far from done.

There’s a few realities for the policy-setting board to confront before it can begin to think about moving to the sidelines.

The biggest and most obvious is that inflation is yet to peak.

The RBA itself on Tuesday revised up its own forecast for the peak in inflation to an annual rate of 8 per cent or more before the end of the year.

The upward revision reflects the surprisingly strong inflation print for the third quarter, which showed consumer prices rising at 7.3 per cent from a year earlier, the highest rate since 1990.

It’s numbers like that that stir memories among older Australians of the deep recession following that inflation surge in the early 1990s. While that version of the Australian economy is long gone, the period brought with it surging interest rates, business collapses and double-digit unemployment.

The next few months will be a testing time for the RBA as inflation tracks upward. Critically, it is crunch time for inflation expectations, which are the main game for the RBA.

Should psychology shift and inflation expectations break their chains, the RBA will face an entirely new war on inflation that will need to be much more aggressive than the one seen since May. Worryingly, there are already indications that inflation expectations are starting to break loose.

Treasurer Jim Chalmers isn’t boosting confidence either, given his continued reminders in media interviews that the world economy is ‘teetering’. Picture: Arsineh Houspian

Inflation expectations jumped 0.5 percentage points to 6.6 per cent this week, the highest value in more than a decade, according to a weekly survey by ANZ and pollster Roy Morgan.

It’s early days, but the psychology change that the RBA fears most might be starting to manifest.

Consumers are more downbeat given the surge in living costs this year and the sense that there won’t be a break in the weather until 2024 at the earliest.

Jim Chalmers isn’t boosting confidence either, given his continued reminders in media interviews that the world economy is “teetering”, while central banks such as the Federal Reserve are indicating little appetite to slow interest-rate increases.

Consumer confidence is at recession lows, as growth in the daily cost of living is easily outstripping mediocre wages growth. Vast numbers of homeowners are also facing a massive jump in mortgage repayment costs next year as low fixed-rate loans convert to much higher variable rates. Confidence among people that are still paying off their mortgages has fallen 15.6 per cent over the past six weeks, according to the ANZ Roy Morgan survey.

With the job market still extremely tight and costs rising on all fronts, pressure on firms to lift wages to retain staff is likely to become more intense.

All of this explains why the RBA is lacing its guidance with the comment that it may yet need to re-accelerate the rate of interest rate increases and return to 50-basis-point moves.

But if the current inflation forecasts prove reliable, and wages growth remains modest overall, the more likely scenario going forward is that the RBA continues to tighten by increments of 25bps each month well into the first half of next year.

For those with long memories, the job of bringing the inflation dragon down is often bigger and more costly than first thought.