RBA may eventually be forced to take stronger stand

Amid rising uncertainty about the outlook for the Australian economy, tensions were high heading into the central bank’s policy meeting. After two days of deliberation, the Reserve Bank of Australia elected to do pretty much nothing.

Official interest rates were left on hold at 4.35% on Tuesday and the RBA’s policy-setting board only tinkered with its guidance to financial markets.

The RBA’s governor, Michele Bullock, said the board ran a ruler over the case to raise interest rates further, and acknowledged the need for greater vigilance. But in the end, the central bank chose to sit on its hands.

The RBA’s inaction comes despite worrying first-quarter inflation data showing that both headline and core measures of inflation remain much too high. Meanwhile, the job market continues to be buoyant, with unemployment hovering just above its lowest levels in half a century. Executives at Australian banks and other business leaders have highlighted the resilience of demand in the economy, warning about adding more fuel to the bonfire.

With the RBA’s war on inflation now in its second year and interest rates up by 425 basis points from their pandemic lows, a case can be made to say that the central bank has been too timid in its battle against price growth.

The RBA is overachieving on its goal of full employment, and underachieving on its mandate to rein in inflation.

Something has got to give, and soon, or the effects of high prices growth over an extended period of time could unanchor inflation expectations. That’s been one of the RBA’s biggest fears throughout this dramatic inflation episode: that expectations of low and predictable price growth will be blown out of the water.

That’s the moment the RBA’s credibility will be lost. And getting the genie back in that particular bottle could take years.

Bullock told reporters after Tuesday’s policy announcement that the RBA is moving cautiously and trying to avoid a recession. That’s commendable in many ways, but it may be the case that an economic downturn will be needed before the inflation problem is finally rooted out.

Other central banks have been more than willing to engineer economic downturns in order rid their economies of the scourge of inflation. It’s a dramatic course of action, but the alternative is far more frightening.

The RBA began to raise interest rates after its global peers and has since then chosen not to tap the policy brakes as hard as places like Canada, New Zealand and the US. As such, the RBA still finds itself a long way short of being able to talk about cutting interest rates, where some other central banks are now pointing in that direction.

It has always been understood by economists that the RBA was late to raising rates, and will almost certainly be among the last to start cutting.

The Australian central bank raised its near-term inflation forecasts sharply on Tuesday, but claimed the setback doesn’t mean inflation will take longer to get back to the desired 2% to 3% target range by late 2025.

The predicted trajectory for inflation feels a little less plausible now.

It seems increasingly hard to believe that after years of high inflation and soaring mortgage interest repayments, the psychology around price growth and wages won’t deteriorate.

The RBA might be badly underestimating the totality of what it must do to win the inflation fight.

The Wall Street Journal