RBA, government must beat inflation together

The Reserve Bank of Australia’s latest 50-basis-point rise in official interest rates to 2.35 per cent puts the Albanese government in a delicate position as it prepares to deliver its first budget next month. After the fastest policy tightening since 1994, the cash rate is within sight of what many would consider to be a neutral stance, neither adding to nor dragging on inflation. This suggests there still may be some way to go but the size of any future rate increases could be smaller as the narrow window to avoid a hard landing for the economy becomes more real.

A lot will depend on whether the federal government chooses to help or hinder the RBA in its inflationary fight. While the government is under considerable political pressure to ease the cost-of-living pressures being felt by many in the community, it must be constrained in how it responds. It is not only mortgage holders who face the pain of rising interest rates. Every percentage point increase in the cash rate affects the federal government’s substantial debt servicing burden as a result of borrowings taken on during the pandemic. At the same time, booming energy prices have turbocharged the nation’s terms of trade, which, when added to the decades-low rate of unemployment, has brought a flood of money into Treasury coffers. The challenge for government is to avoid fuelling a vicious cycle in which spending by government forces the RBA to keep lifting rates.

The RBA has said it expects that rates will need to be lifted further in coming months as it moves to bring inflation back within its target range of 2 to 3 per cent. The anecdotal evidence is that households are still resilient to the rising costs of higher rates. But, as Jim Chalmers told parliament on Tuesday, the latest rate increase will add $145 to the monthly payment on an average $500,000 mortgage in addition to the $475 that has been added since rates started to rise in May. Given the lag between the rise in official rates and higher mortgage payments, it is logical that the full impact of the rate rises to date has yet to work its way into household budgets. The evidence is that while consumer sentiment has softened, spending has not. Australian Bureau of Statistics figures released on Tuesday showed an 18.4 per cent rise in household spending in the year to July, with services spending up 28.4 per cent since last year and goods purchases rising by 9.5 per cent. All eyes will be on what happens to inflation in the coming months. There are signs that inflationary pressures are starting to ease in areas that previously have been of concern.

RBA governor Philip Lowe said global factors explained much of the increase in inflation but there also were widespread upward pressures on prices from strong demand, a tight labour market and capacity constraints in some sectors of the economy. It is encouraging that timber prices, a big driver of domestic inflation, are lower and the price of oil has been consistently under $US100 a barrel. The RBA expectation is that domestic inflation will peak later this year, then decline back towards the 2 to 3 per cent range. The RBA’s central forecast is for CPI inflation to be about 7.75 per cent across this year, a little above 4 per cent in 2023 and about 3 per cent in 2024. Dr Lowe said wages growth had picked up from the low rates of recent years and there were some pockets where labour costs were increasing briskly. He did not comment on the dangers of a wages-price spiral that could fuel inflation further. But he said: “Given the tight labour market and the upstream price pressures, the board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead.”

The government cannot avoid responding to immediate cost-of-living concerns but it must remain focused on the medium to long term. Anthony Albanese sought to blunt the impact of Tuesday’s rate hike announcement with confirmation he would introduce legislation in the current sitting of parliament for cheaper subscription medicines and higher childcare subsidies. Dr Chalmers said it was not for the government to interfere with independent decisions of the Reserve Bank. The government’s job, the Treasurer said, was to do “what we responsibly can to help Australians deal with these pressures in the near term and to build a much more resilient economy into the future that is able to withstand some of these global and domestic shocks”. Wisely, the government remains committed to restoring the full fuel excise when the temporary reduction expires at the end of the month. The Prime Minister told Labor MPs to expect “difficult decisions” in the budget next month and urged them to remain disciplined despite growing calls for more government spending. Rather than giveaways, the government must assist the RBA in its inflation challenge by sticking to the hard task of budget repair and growing wages through increased productivity.