Reserve Bank holds interest rates on a narrow path

A diplomatic Reserve Bank of Australia governor Michele Bullock clearly has absorbed the political nature of her position but is not punching back or backing down. Leaving the cash rate on hold on Tuesday, Ms Bullock said the RBA board meeting had not specifically considered a rise but that in the near term the board “clearly does not see interest rate cuts”. Monthly inflation figures out on Wednesday will give an indication if the RBA settings are still restrictive enough to gradually pull inflation back to where the bank wants it to be.

On the negative side, labour markets remain tight and productivity is back to the 2016 level, having fallen by 0.8 per cent in the June quarter. High government spending and public sector employment and wage rises are dragging back the private sector. As we reported on Tuesday, state governments are expected to borrow more than $100bn this financial year, with just under 60 per cent of new state and territory debt to be issued by Queensland and Victoria.

The combined interest bill on growing federal and state debts is expected to climb to $44bn this financial year – equivalent to the annual cost of running the National Disability Insurance Scheme. Before the pandemic, in the 2018-19 financial year, the combined interest expenses of state, territory and federal governments were just $25bn. This ballooning interest bill exposes the wrongheaded belief expressed during the extended period of quantitative easing and ultra low interest rates that government borrowings were pain free. When economic growth exceeded the rate of interest on borrowings this might have seemed attractive, but that is certainly no longer the case. For now, the RBA is persisting with its pursuit of a narrow pathway to a soft landing.

Ms Bullock did a good job explaining why easing rates in other countries – notably Canada, New Zealand and the US – did not translate automatically into a valid reason rates should be cut here. New Zealand and Canada have experienced sharp rises in unemployment. The US had done better, pulling back inflation to within target. But these other countries are cutting official rates from a peak of more than 5 per cent compared with the RBA’s top of 4.35 per cent.

Ms Bullock resisted invitations to repeat her comments that suggested government spending was making her job more difficult. She let the numbers do the punching. Ms Bullock repeated the fact that the RBA would not be fooled by Jim Chalmers’ transparent attempt to buy a lower inflation figure with electricity bill giveaways in the federal budget.

She said headline inflation was expected to fall further temporarily as a result of federal and state cost-of-living relief. But in underlying terms, as represented by the trimmed mean, inflation was 3.9 per cent across the year to the June quarter. Ms Bullock noted that underlying inflation had been above the midpoint of the target for 11 consecutive quarters and had fallen very little across the past year.

In short, the economy remains tight. While demand is not growing very much, total demand is still more than we can supply. That is the central message for big spending, low-productivity governments at all levels.