Two rate rises and a possible hard economic landing for Australia on Bill Evans’ radar

Westpac’s chief economist expects the RBA’s terminal rate will be 4.6 per cent and there won’t be any cuts until next May at the earliest.

Westpac chief economist Bill Evans. Picture: John Feder

Bill Evans expects two more interest rate rises by the Reserve Bank, increasing the risk of a hard landing for the Australian economy as the central bank continues its crackdown on inflation.

Nine months ago, Westpac’s chief economist told this column that the “right approach” for RBA governor Philip Lowe would be to “strengthen the rhetoric”.

He said a tough approach was needed to reinforce his inflation-fighting commitment – as his US counterpart, Jerome Powell, had done at Jackson Hole a week ­earlier.

Inflation had soared to 6.1 per cent for the year to June 2022 amid supply chain bottlenecks and excessive consumer demand following unprecedented stimulus during the Covid-19 pandemic.

In light of the fact that inflation had been above the RBA’s 2-3 per cent target band on annual basis since mid-2021, Evans feared a repeat of the policy mistakes of the 1970s and ’80s, when central banks allowed expectations of high inflation to become entrenched, ultimately requiring drastic increases in interest rates that caused multiple recessions.

He said central banks needed to be forceful enough to make businesses doubt that consumer demand would remain strong enough to continually increase wages and prices, thereby heading off the risk of a classic wage-price spiral.

The increase in consumer prices would go on to hit a four-decade high of 7.8 per cent for the year to December, before cooling to 7 per cent in the year to March.

But last September, Evans believed that an increase in the cash rate to 3.35 per cent by February would cool the economy enough to remove the risk of inflation becoming entrenched.

He said that taking the cash rate to 4 per cent would be “very dangerous” for the economy, due to the amount of leverage on the part of Australian households.

Fast forward to this month and the cash rate hit 4.1 per cent as the RBA worried that a resurgence in house prices and a big increase in award wages would fuel consumer inflation expectations.

After that increase and hawkish guidance from the Reserve Bank – following a big increase in award wages the week before – Evans lifted his terminal cash rate forecast to 4.35 per cent.

And this week, he added another interest rate increase to his forecasts after stronger than expected jobs data. Westpac now sees a “terminal” RBA cash rate of 4.6 per cent, which is close to the ­consensus.

It comes after the ABS said employment rose by 76,000 in May, well above the 17,500 rise expected by economists, and the unemployment rate unexpectedly fell to 3.6 per cent.

Evans also warns interest rates will need to be higher for longer than previously expected.

He says that with the jobs market remaining tight for longer than he expected, the RBA board will “require further convincing” that the inflation path will land within the 2-3 per cent target zone by June 2025.

In his view the RBA will have little choice but to hold off on “much-needed rate relief” by three months. Accordingly, he now expects the RBA to start cutting rates by 25 basis points next May.

He expects the RBA to cut again by 25 basis points in August and November 2024 and keep cutting in 2025, eventually lowering the cash rate to 3 per cent – 110 basis points below the current level.

But of even more concern is the fact that Evans also sees a risk of rates exceeding 4.6 per cent.

“Given the notable resilience of the labour market to date, the prospect of adjustments to industrial relations arrangements that will add pressure to wages growth, and the lift to wage expectations from recent award wage decisions, we cannot dismiss prospects of even further increases in the cash rate,” he says.

“For now, we will bow to the prospect of ongoing tepid growth eventually containing these inflation pressures, expecting rates to go on hold beyond August,” he adds.

“But we cannot entirely dismiss these risks and the inevitable implications for the state of the economy in 2024.”

This can only be bad news for the economy. Whether or not it enters a “technical recession” – defined as two consecutive quarters of negative economic growth – will be purely academic.

Based on Westpac’s forecast cash rate peak of 4.6 per cent, Evans now tips annual economic growth of just 0.6 per cent in 2023 and 1 per cent in 2024.

His quarterly growth forecasts now contain one negative quarter – minus 0.2 per cent in the March quarter of 2023 – with quarterly growth of 0.1 per cent and 0.2 per cent expected either side of that.

“Our forecasts are still positive although well within the range of forecast error,” Evans warns.

“Consequently, on this definition, we are not forecasting a technical recession but recognise the high degree of uncertainty.”

Of course there are a range of other ways to define a recession.

As Evans puts it, an increase in the unemployment rate from 3.5 per cent at the start of 2023 to 5.3 per cent at the end of 2024 “might fit an alternative definition of a recession”. His forecasts also imply per capita spending and GDP recessions in 2023 and 2024.

Worryingly, the key driver of this insipid growth outlook is household consumption, now expected to grow by just 0.3 per cent in 2023 and 0.6 per cent in 2024.

“This consumption profile is consistent with the very weak measures of consumer sentiment we have seen since the onset of high inflation and rising interest rates in 2022,” Evans adds.

It also implies much weaker consumption growth during the deep recession years of the early 1990s.

Investment growth in infrastructure, renewables and mining is expected to provide some offset.