RBA money creation to drive up Australian rates sooner, says CBA

Canberra’s deluge of pandemic stimulus could come with a sting in its tail as inflation rises, warns CBA’s Gareth Aird.

Commonwealth Bank’s Head of Australian Economics, Gareth Aird.

The deluge of fiscal stimulus deployed by Canberra to soften the impact of the Covid-19 pandemic in Australia, could come with a sting in its tail as the central bank money creation that financed the government’s spending drives inflation higher.

Gareth Aird, the head of Australian Economics at the Commonwealth Bank of Australia, expects inflation to spike in coming years, triggering interest-rate increases from early 2023, and pushing up mortgage lending rates at a time of rapid growth in household debt.

“Fiscal stimulus due to the Covid shock has been indirectly funded by Reserve Bank of Australia bond buying, which constitutes money creation,” Mr Aird said.

“We expect the potent combination of quantitative easing and direct cash payments from government to households will boost future spending and lead to higher consumer inflation over the next few years,” he said.

CBA forecasts underlying inflation to be around the midpoint of the RBA’s 2.0 per cent - 3.0 per cent target band by mid-2023. In contrast, the RBA expects underlying inflation to be 2.0 per cent at mid-2023.

The warning from CBA comes as RBA Governor Philip Lowe recently chided financial markets for pricing in interest rates increases as early as late 2022.

Household deposits have risen faster than credit in Australia due to government transfer payments, while the RBA’s bond buying program, which has essentially funded the fiscal support payments, has boosted the money supply, Mr Aird said.

The wash of cash in savings accounts will ultimately take core inflation back to within the RBA’s target band earlier than the central bank expects, forcing interest rates higher, he said.

An unusual situation occurred in 2020 whereby bank deposits ballooned relative to credit growth. Some individuals were also given the ability to tap retirement savings to get through the crisis, adding to the cash in the system. But it was the wave of fiscal stimulus unleashed by Canberra and state governments that drove bank deposits higher.

“Households do not have to repay this money in the same way they have to repay a loan. So the lift in deposits is potent in the context of thinking about future spending,” Mr Aird said.

CBA estimates that over the pandemic to mid-2021, household deposits have risen by around $70 billion more than they would have otherwise. That’s equal to 3.5 per cent of GDP.

That figure is expected to swell to $120 billion by the end of 2021 or 6 per cent of GDP.

Households that have also strengthened their balance sheet by accelerating debt repayment, so they will feel more confident to spend in the future, Mr Aird said.

If households spend around 15 per cent of the accumulated savings in 2022, the economy will see a direct boost in consumer spending of $A35 billion, the equivalent to 1.75 per cent of GDP.

The extraordinary injection of cash into the household sector from the government, which has contributed to the significant build up in savings, has been funded by public debt issuance, and the biggest buyer of government debt by far over the pandemic has been the RBA.

“The RBA’s huge bond buying program, which has largely financed the fiscal expansion, has in many respects blurred the distinction between fiscal and monetary policy,” Mr Aird said.

“If one takes a step back to look at what has occurred over the pandemic, conceptually it reveals that we have entered uncharted territory in Australia. Transfer payments from the government have been indirectly funded by the central bank through money creation,” he said.

The Wall Street Journal