How the Reserve Bank missed the boat on inflation

RBA governor Philip Lowe. Picture: Louie Douvis - Pool/Getty Images

The Reserve Bank’s latest forecasts for the economy are a humiliating admission of failure. They are also a bewilderingly bizarre statement that Tuesday’s rate hike really should have been 0.4 per cent.

The RBA is now forecasting for the first time that inflation will stay above the top of its 2-3 per cent mandated target range all the way into 2024 – even after it has delivered the very rate hikes that it had long promised not to start to deliver until 2024.

“Yesterday” – or to be more precise, until November last year – the RBA was explicitly promising not to lift its official cash interest rate from 0.1 per cent until 2024.

And I quote from RBA Governor Philip Lowe’s October statement: “The central scenario for the economy is that this condition (for a rate hike) will not be met before 2024.”

The central point to understand is that the RBA did not see inflation accelerating to above 3 per cent even if it left its cash rate at 0.1 per cent all the way through both 2022 and 2023.

It did not see inflation accelerating even as it was actually doing so in the December quarter, and so before the further specific inflation pressures sparked by Russia’s attack on Ukraine.

Now, in a bizarre 180-degree turn, it sees inflation staying too high even after it hikes, and keeps hiking, by as much as 200 points through 2022 and 2023.

You could not ask for a more striking statement of failure from a central bank: that it didn’t have a clue what was happening in the economy, and consequently didn’t have a clue what it needed to do with interest rates.

At the start of October last year I wrote: “Inflation is coming, ready or not. Indeed, it’s already here if somewhat muted for the moment by the lockdowns in NSW and Victoria.”

This was all confirmed when the official ABS inflation figures for the September quarter were released at the end of October.

RBA governor Philip Lowe. Picture: Louie Douvis - Pool/Getty Images

They showed inflation of 0.8 per cent for the quarter – with critically that inflation topping 3 per cent on an annualised basis even when the Victorian and NSW economies had been locked down for much of that quarter.

Inflation duly kicked up to 1.3 per cent in the December quarter as the two big states opened up and the economy started to roar.

Then we got that supposedly “shock” 2.1 per cent for the March quarter that gave us 5.1 per cent for the year, waking the RBA from its slumbers and forcing this week’s official rate hike.

It was a rate hike that should have been the 0.4 per cent given the RBA is now forecasting inflation will actually accelerate, and to just under 6 per cent for 2022. Kicking off with only a 0.25 per cent made no sense given that forecast.

Especially as it was a rate hike that came at least two months late.

I would have preferred the RBA to make its first hike in February, off the back of the December quarter’s 1.3 per cent inflation – and back then it could have appropriately started with the gentle “we’ve finally woken up” 0.15 per cent.

But given all that sustained “not before 24” rhetoric from Lowe, I argued late in January that he should at the February meeting “open the door to an interest rate hike at its very next meeting in March”.

Well, he chose not to. His statement after the February meeting went out of its way to hose down any suggestion of accelerating inflation, and so the possibility of a rate hike.

This sentence from Lowe is beyond embarrassing and, frankly, an indictment, in the context of both the March quarter inflation numbers and these latest RBA inflation forecasts. “While inflation has picked up, it is too early to conclude that it is sustainably within the target band”.

Failing to move before the election that was always going to be called at the end of March left Lowe in exactly the pickle I suggested: having to choose between a mid-campaign initial hike, or what would have been worse, not hiking in the face of unacceptably high inflation.

A key point that’s been missed in all the frenzy since Tuesday is the way Lowe and the RBA have ditched their entire analytical structure.

The central argument Lowe has been making is that he would only hike when inflation was sustainably in the 2-3 per cent band and that would only happen when wages were rising at something more than 3 per cent.

As the RBA, even in February, didn’t see wages rising at 3 per cent-plus until 2024, that’s why it didn’t see inflation being sustained over 3 per cent, and so why it didn’t think it would hike through 2022 at least.

Also, obviously, why Lowe most certainly wasn’t going to signal in February a March hike.

Now, Lowe’s not only hiked in May, he’s signalled further hikes – even though he still doesn’t see wages rising by more than 3 per cent.

The RBA forecasts 3 per cent for wages through 2022, edging up to just 3.3 per cent by June next year.

So why is the RBA hiking, when the basis for sustaining inflation ain’t there – in its, well, “judgment”?

But let me repeat what I wrote earlier in the week. It’s beyond silly trying to forecast into the uniquely unusual economic turmoil consequent on the actions of two totalitarian leaders.

The Russian attack on Ukraine is not only a potentially huge and unpredictable geopolitical event but a uniquely novel geo-economic one as well.

Similarly with China’s zero-Covid strategy – like Ukraine, entirely at the whim of a single, unchallengeable, person. And imposed over the implosion of China’s two-decade long export-infrastructure growth boom.

Then add on what the Fed will – might – do, Wall Street’s temper tantrums, and the Fed’s likely reaction.

There’s a lot of “interesting” year to come.