Outlook for China, Europe and US guide RBA’s hand when it comes to combating inflation

US Federal Reserve board chairman Jerome Powell. Picture: AFP

Reserve Bank deputy governor Michele Bullock gave an important insight into the thinking at the top levels of the central bank in a question-and-answer session with Bloomberg on Tuesday, after her speech on the bank’s bond buying program during Covid-19.

In her comments, Bullock confirmed that the RBA is taking a different view of the world than central banks in Europe, and particularly the US – one which is more concerned about the implications of a world economic slowdown on its economy.

It’s a view that is already seeing a very different RBA to the hawkish, “whatever it takes to fight inflation first” tone from US Federal Reserve chair Jerome Powell – a tone that will see the RBA taking its time to put up rates with a much closer eye on the implications for the Australian economy.

While the RBA will respond to further rises in inflation with higher rates, it is not on a mission to squash it dead at all costs.

While the market on Tuesday focused on RBA’s bombshell news that it suffered an unprecedented accounting loss of almost $37bn in the 2021-22 year, as a result of a major exercise in quantitative easing in response to concern about the fallout from Covid-19 – leaving the bank in a theoretical period of negative equity to the tune of $12.4bn – the deputy governor expressed her concerns about the state of the world economy.

She was surprisingly frank about the global outlook – concerns that are clearly affecting the RBA’s thinking.

“The outlook for the world economy is looking quite uncertain and quite worrying,” she said.

“That has implications for us as it tends to flow through to commodity prices. This is something which is very uncertain and is on a bit of a knife edge.”

She confirmed the RBA was concerned about the economic outlook in China, Europe and the US, “all for different reasons”.

There were two main concerns with China. The first is its “zero Covid-19 approach” with ongoing lockdowns and restrictions having a volatile impact on the economy including on supply chains and consumer demand.

Second were the worries about the problems in the property market, which she said were ongoing despite moves by local governments to support the market. The property market is a significant part of the Chinese economy.

Reserve Bank deputy governor Michele Bullock. Picture: John Feder

“It is very important for the health of the economy. It is also important for steel demand and for (demand) for iron ore.

“Concerns about China are around zero Covid and the property market and what that potentially means for growth in China and hence the flow on to ourselves,” she said. Her comments came after Australia’s Ambassador to China, Graham Fletcher, last week confirmed that Australia was now expecting Chinese economic growth to come in at around 3 per cent, well down from figures of more than 5 per cent in the previous two years.

The federal government’s estimates are lower than the 4.4 per cent forecast issued for China by the OECD in June and below the IMF’s forecast of 3.3 per cent (down from the 4.4 per cent it predicted in April).

Internationally, Bullock said, there were also concerns about rising rates in Europe and the US.

“The US has excess demand and its rates are going to have to continue to go up quite sharply,” she said. “Europe has got its own problems. It’s got inflation, but it also has a massive energy shock which is going to impact their production.”

As a trading nation heavily dependent on commodity prices, Australia is in a very different place than the US or Europe.

As Bullock pointed out, Australia’s inflation rates are not as high as elsewhere (at the moment), nor is it subject to quite the same energy price hikes as Europe, and wages in Australia have not begun to spiral upwards.

In short, the central bank in Australia is approaching its task with a different mindset than that in other countries, particularly the US where inflation and inflationary expectations are higher.

What is apparent from the revelations about the extent of the RBA’s bond buying program in the pandemic was how seriously worried it was about the situation at the time from the outbreak of Covid-19 in early 2020.

Bullock talked of concerns about potentially “catastrophic” implications from Covid-19, including the possibility of having to have a morgue in Sydney’s Domain to cater for the bodies.

The fact that Australia got through the crisis as well as it did – with an economy stronger now than anyone expected – was in part due to the unprecedented bond buying program undertaken by the bank from 2020 to early this year.

But those days are behind us.

Stimulus is being withdrawn and rates are going up.

The RBA report was also a reminder that the banking system is still enjoying 0.1 per cent interest rates from the multi-billion term lending program extended by the central bank during Covid.

Once that runs off, the banks will be under even more pressure to raise mortgage rates.

Bullock deflected a question that the RBA may be wary about jacking up rates too high too quickly because of the high levels of household debt in Australia, pointing out other factors making Australia different from other economies.

Rates will go up but the RBA is keeping a wary eye on the world economy, particularly China.

Australia’s political relations with China may be strained with some areas of trade affected, but its vulnerability to the strength of the Chinese economy is still high.

While the official figures for Australia are strong, concerns that the world economy could be on a “knife edge” – and what that could mean for the local economy – will see the RBA’s rate tightening err on the more conservative side than some of its global peers.