Why the RBA won’t raise interest rates

Reserve Bank of Australia governor Philip Lowe. Picture: NCA NewsWire/Jeremy Piper

You have to hand it to Reserve Bank governor Phil Lowe for his interest rate juggling act, which is getting harder and harder as his colleagues around the world increase rates, inflationary pressures are on the rise and Australia is facing a knife-edge federal election within the next two months or so.

Lowe is doing his best to argue that Australia’s inflationary outlook is different to that of other countries such as the US and the UK, and that he needs more time to think about what is the right time to put up rates.

This was the basis of his speech to a business conference in Sydney on Wednesday.

The bank’s official line is that it will not increase the cash rate until inflation is “sustainably” in its 2 to 3 per cent target range.

Australia’s latest headline inflation figure is running at 3.5 per cent – boosted, in part, by rising oil prices and supply side constraints due to Covid shortages and disruptions, with the underlying rate running at 2.6 per cent.

This would give grounds for a rate rise but Lowe says he wants more evidence of a sustainable rise in inflation, and is also watching wage rises, which the RBA believes have continued to remain low.

“In this uncertain environment – and with the starting points for growth and underlying inflation in Australia – we can take the time to assess the incoming information and review how uncertainties are resolved,” Lowe said.

“Given the outlook, though, it is plausible that the cash rate will be increased later this year.

“I recognise there is a risk to waiting too long, especially in a world with overlapping supply shocks and a high inflation headline. But there is also a risk of moving too early.”

On the other side of the ledger (adding to pressure to put up rates), as he admitted, was the fact that the war in Ukraine has “added to the complexities”.

“The Reserve Bank will respond as needed and do what is necessary to maintain low and stable inflation in Australia,” he said.

Of course, what Lowe knows full well is that the RBA will have to start putting up rates soon after the election.

One could argue that the official cash rate should already have edged up by now from its historic low of 0.1 per cent.

The bank has already ended its Covid-induced bond purchase program, yield target and the provision of new funding under its Term Funding Facility, a move which is shifting the RBA away from its loose monetary policy over the past two years. One could argue these mean monetary policy is already tightening.

What Lowe is doing now is working as hard as he can to protect the RBA itself against any political backlash from putting up rates ahead of an election.

To put rates up in the months leading up to an election would open the bank to political attack from the Morrison government.

As many have found out over recent years, it has ways of making its displeasure felt to specific parties when it needs to.

Technically the bank is independent of the government but in practice it is not quite that clear cut – which the photos of treasurers and RBA governors meeting up in recent times have only confirmed.

Its not quite the case that former PM and treasurer Paul Keating once said, apparently in jest, that Martin Place does what the treasurer wants.

But to jack up rates before an election is not good for the RBA either, which one of Lowe’s predecessors found out.

The treasurer of the day, inter alia, will be the one who gets to pick who Lowe’s successor will be.

The natural order of things is for the governor to come from the ranks of the bank, but Keating broke the mould by putting treasury secretary Bernie Fraser in the job.

Thankfully the RBA has backed off from its earlier declaration that it might not need to put up rates until 2024 – a declaration that must have sent waves of eager young home buyers who have never seen a rate rise headed towards crowded property auctions.

Former treasurer and current chair of the Future Fund and Nine Entertainment, Peter Costello, was scathing about this statement in his comments to the same conference on Tuesday, urging the bank to abandon its rhetoric and to start putting up rates.

He urged the RBA to “get with the (interest rate) curve, rather than behind it”.

He said the combination of very low interest rates, large fiscal deficits and a big bond buying program was “rocket fuel” for the economy.

He described the RBA’s bond buying program over the past two years as a “bond mine”. This had seen the RBA triple its balance sheet from about 10 per cent of GDP to about to 30 per cent.

“By world standards, this is very large,” Costello said.

Lowe’s argument is that the forces behind inflation are different here to those overseas and that he needs time to see whether headline inflationary pressures due to Covid will wash their way through the system.

But inflationary pressures continue to mount – with shortages, the war in Europe and a relatively new factor now being assessed more seriously – the high cost of companies and economies having to transition to a lower carbon environment.

What Lowe and his board really think will not be known until the first board meeting after the election – most likely the June board meeting. It’s not hard to predict that it will see a cautious 25 basis point rise.

The Commonwealth Bank economics team is predicting a rise in the cash rate in June, going up in gradual stages to around 1.25 per cent. Other economists are opting for a slower start to hikes but a larger end rate.

Hopefully the homeowners who have rushed in and borrowed over the past few years, thinking rates wont rise until 2024, have a financial cushion when they do go up. Hopefully would-be borrowers between now and June have got the message that the bank’s rhetoric is already changing.

If not, watch out for a big turn in the housing market when rates are jacked up over the year from June.