Global markets are delivering a clear message to Australia that interest rate reductions will not be tolerated while our governments spray salary money at increasing numbers of public servants and hinder productivity improvement.
The global message comes via the Australian dollar, which has now fallen below US65c. But there is also a local interest rate warning for the Reserve Bank from retailers who tell me that, thanks to government “stimulations” retail sales in the approach to the Black Friday major price cuts are very “encouraging”.
It’s a good sign for Christmas, but it’s not a good sign for our central bank, who wants an economic slow down to enable inflation to fall.
The US inflation rate is now running at 2.6 per cent, which is within the RBA’s 2-3 per cent interest rate guidelines but higher than the US Federal Reserve’s 2 per cent target.
Leaving out Australian government subsidies, the Australian inflation rate in the September quarter was 3.5 per cent, which was higher than a year ago.
While in Australia inflation is higher than the US, our official interest rate at 4.35 per cent is below the US official rate 4.75 per cent.
In normal circumstances, we could expect that the Fed would reduce rates at its next meeting. Indeed, the markets had been expecting a succession of interest rate reduction in 2025 – an inflation victory present to the US people.
But the US interest rate scene is confused by the promise of incoming president Donald Trump to put higher tariffs on imports including a 60 per cent tariff on China.
Those tariffs, plus lower taxes and the plan to send millions of illegal US migrants back home, are inflation-boosting moves which will make the Fed hesitate to further reduce interest rates at this time.
Against that, Trump has given Elon Musk the task of slashing US government expenditure which will send a deep shiver around US public servants which will affect their spending patterns.
In addition, Trump is promising to lower energy prices by increasing production of gas and oil. Fed chair Jerome Powell has indicated he will not reduce interest rates if he is faced with higher inflation as a result of the Trump measures.
When global inflation broke out in the Covid-19 era, the Fed decided to get tough and increase its official rate above 5 per cent. Australian banks had loaned large sums to home buyers on flexible rates, so had we matched the US, the consequent mortgage stress would have been much greater.
So we held back our interest rates and the booming iron ore prices enabled the currency to hold its ground.
But now iron ore prices are falling and Australian state and federal governments have thwarted the RBA’s plan to slow the economy via interest rates by engaging on massive hiring sprees using borrowed money.
The federal government plus NSW and Victoria also embraced badly executed renewable energy projects, which boosted power costs. Add that to the industrial relations legislation, which is designed to push up labour costs and lower productivity, and we have a cocktail that longer term will require Australia to have higher interest rates than the US.
Accordingly, we are being swept up into the US economic turmoil. And that turmoil could get ugly because Jerome Powell has declared that he wouldn’t step down if Trump, who has previously criticised Powell’s performance, asks him to resign.
Powell added that it is against the law for a US president to fire or demote the Fed chair.
Theoretically, if Trump was elected president of Australia he would reduce the public service and repeal the industrial relations laws but if Opposition Leader, Peter Dutton put forward those policies he would be smashed in the May election.
The best he can do is promise an industrial relations summit involving workers and not just unions and employers. But he can start to rectify the energy mess.
But if Trump policies prevent the US official interest rates from falling then we will not have the options to reduce our rates sufficiently to relieve mortgage stress without sacrificing the currency. A lower local dollar lifts inflation.
Temporary subsidies obviously help consumers, they are not used by the RBA or the markets to determine official interest rates and the currency levels.
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