US Federal Reserve and Reserve Bank of Australia signal central banks will take fight to inflation

US Federal Reserve chairman Jerome Powell says the argument that inflation is transitory ‘has fallen apart’. Picture: Bloomberg

The message from both the US Federal Reserve and the Reserve Bank of Australia this week is that central bank regulators are clearly repositioning to take on rising inflation.

The argument that inflation is transitory has been lost.

In the words of Fed chairman Jerome Powell: “The story has fallen apart.”

Ironically this is in part due to new, hopefully transitory events – the war in Ukraine, further pandemic lockdowns in China, and in Australia, the floods.

These have extended inflationary pressure from supply chain problems and demand pressure to rising energy prices.

On Thursday, Westpac chief economist Bill Evans joined other economists who revised their interest rate forecasts this week in response to the statement from Tuesday’s RBA meeting.

The bank signalled that it had finally run out of patience.

The word patient, so loaded in recent speeches by the governor had been dropped.

From June, Westpac expects a sequence of rate rises covering most months in 2022, reaching a cash rate of 1.25 per cent by year end. Rates will continue to rise until mid-next year, peaking at 2 per cent which Evans says will be six months after the US Fed rate cycle peaks.

Most economists do not see the RBA raising rates until after the May federal election.

That experiment occurred during the 2007 election campaign when Peter Costello was treasurer. The RBA lifted rates by 0.25 per cent to 6.75 per cent.

Costello could only apologise to homeowners facing mortgage rates of 8.5 per cent and argue that the rise came due to a stronger economy. It was Kevin Rudd’s election and the end of an era for the Coalition.

Today the former treasurer joins others who say RBA governor Phil Lowe is behind the curve.

Lowe has moved ground since the March meeting.

In that time the unemployment rate has dropped from 4.2 per cent to 4.0 per cent.

Westpac’s forecast for unemployment at year end has fallen from 3.75 per cent to 3.25 per cent.

This compares with the federal budget forecast of 3.75 per cent but not achieved until the September quarter of 2023.

Record low unemployment is a powerful boast for the government but to date it has not been able to trigger wages growth.

This is a hot-button issue for Australians given rising prices.

Bill Evans expects a lift in wages growth in 2023 with a peak of 4 per cent compared to Westpac’s previous peak of 3.5 per cent.

Question – has Lowe become comfortable enough that falling unemployment will deliver wages growth and he can now move on rates? Or is pressure from inflation the bigger force?

The RBA board says it will consider fresh data in its decision; on inflation in late April; wages in mid-May; and the national accounts data on June 1.

This has been taken as a signal for a June tightening.

Evans says the RBA board, by creating a clear expectation that it will start raising rates in June, is showing it is willing to risk political controversy.

“Particularly around any potential discussion of the role of the federal budget in changing the board’s stance,” he says. “Being aware of such complications but still being prepared to change the stance emphasises the board’s determination to change the policy message.”

In the US, Americans live with inflation levels of 7.9 per cent, a level not seen in 40 years. On Thursday, the Fed released minutes of its March meeting, when it raised the benchmark rate from around zero to between 0.25 per cent and 0.50 per cent.

The minutes reveal that many officials wanted the rise to be 0.50 per cent but after the outbreak of war in Ukraine decided against it; 0.50 per cent hikes are coming.

The minutes also show the Fed is planning to embark on quantitative tightening by reducing its trillion-dollar balance sheet by a generally agreed $95bn a month to counter inflation.

And just to make sure no one is confused by the messaging, Lael Brainard, a Fed governor with a dovish reputation who has previously warned against pulling QE too early made a poignant speech on Tuesday about the need to reduce high inflation.

If confirmed by the Senate, Brainard will become Fed vice-chairwoman.