RBA readying to go easier on interest rates brake pedal

The Reserve Bank’s shock-and-awe campaign of consecutive 50-basis-point interest rate increases to cool off inflation is coming to an end.

Philip Lowe, Governor of the Reserve Bank of Australia. Photograph by Arsineh Houspian

The Reserve Bank’s shock-and-awe campaign of consecutive 50-basis-point interest rate increases to cool off inflation is coming to an end.

The time to slow down the pace of policy tightening to something a little less thunderous and survey the damage of what has been the most aggressive period of interest-rate increases since the mid-1990s is near at hand. In September there could be one more salvo of 50 basis points from the RBA, but after that it looks set to nudge interest rates up more cautiously, no longer lighting up the night sky with blasts from its heavy guns.

Importantly, as the official cash rate probably moves well above 2 per cent next month, the RBA will for the first time since starting to increase rates in May have some confidence that it is starting to get on top of the inflation threat.

The RBA delivered a third consecutive 50-basis-point interest rate rise after a policy meeting on Tuesday, raising the official cash rate to 1.85 per cent, marking 175 basis points of tightening in the space of a little under 100 days.

Tapping the policy brakes with such enormous force has already registered in the housing market, where prices are starting to fall, particularly in major cities.

If the retreat in house prices gathers steam, already depressed consumer confidence will drop further and consumers will hit pause on spending.

Most forecasters already have built-in assumptions that house prices will fall about 10 per cent from peak to trough. The RBA would be working with similar ­assumptions.

Apply the heavy brakes too long, and the risk of a recession next year will rise quickly. Already the warning signs are in place, with the RBA forecasting below-trend GDP growth of just 1.75 per cent through both 2023 and 2024.

So there is a need to back off the speed at which interest rates are rising, but not to pause.

While belts are tightening all over the country and mortgage borrowing costs are surging against the backdrop of the biggest jump in living costs in a generation, there still seems to be a lot of life in the economy.

Consumers continue to spend and businesses are hiring. There is even a real possibility that unemployment will fall from its current 50-year low of 3.5 per cent.

The RBA looks set to lower its forecasts for unemployment on Friday in a quarterly policy review, and could suggest that the economy has already exceeded full employment, possibly by a long way.

Very few firms are reporting that they want more demand across the economy, but many are complaining they can’t hire staff.

Despite everything, there is still some zip in the economy.

With inflation set to approach an annual peak of close to 8 per cent this year, the RBA will continue raising interest rates, albeit at a slower pace.

So where does it end?

RBA governor Philip Lowe has estimated a neutral policy rate is about 2.5 per cent. It is a level that is theoretically consistent with the economy neither cooling, nor heating. So that seems to be the first goal. But it is virtually certain that interest rates will need to move higher in order to squeeze out inflationary pressures and there is a lot of uncertainty around all of this, and the RBA has admitted to that.

Ideas about where the neutral policy rate sits shift from year to year as conditions in the global economy change.

If there are five economists in a room, you will probably get 10 opinions on the matter.

But what is clear is that the first phase of the RBA’s mission to raise interest rates, where it had to play catch-up, will be done by September. But just how far they rise beyond that remains clouded in uncertainty.

Dow Jones Newswires