Rate rise: Taming the inflation genie

RBA governor Philip Lowe. Picture: Getty Images

The first 50 basis point hike in the cash rate since February 2000 has restored some of the Reserve Bank’s credibility, and the triumph of the born-again hawks is set to continue.

In RBA governor Philip Lowe’s own words, the board expects to take further steps to normalise monetary conditions “over the months ahead”.

The 75 basis points of rate hikes since the May board meeting represents a huge reassessment by the board of the nation’s strongest inflationary surge since the late 1980s, with power and petrol prices likely to drive the inflation rate above 7 per cent.

The Covid emergency settings have now given way to an inflation emergency.

While AMP chief economist and head of investment strategy Shane Oliver doesn’t expect a recession, he says there’s a clear risk now that the RBA might go too far in its determination to put the inflation genie back in the bottle.

The big unknown, he says, is the “breaking point” for households, although recent consumer confidence surveys by ANZ/Roy Morgan and Westpac have hardly inspired optimism.

It now appears that the dip in confidence is partly, at least, a reaction to the real start of policy tightening last October, when the RBA abandoned its 0.1 per cent bond-yield target.

That was the cue for rock-bottom rates on fixed-rate mortgages to start their inexorable climb.

Oliver, who predicted a 50 basis point hike if the RBA chose not go with 40 basis points, has stuck with his forecast that the cash rate will finish the year at 1.5-2 per cent, peaking at 2.5 per cent in 2023.

By joining with the likes of the US Federal Reserve and Bank of New Zealand in aggressively lifting official rates, the RBA is hoping to avoid inflation becoming embedded. It could also create the potential for more modest 25 basis point adjustments in the coming months.

There are many unusual aspects to the current economic challenge faced by policymakers.

For example, previous rate-hiking cycles have occurred amid reasonably solid house price growth. This time, prices have already started to dip, particularly in the main markets of Sydney and Melbourne, so the negative wealth effects are coursing their way through the system.

The price impact of a 50 basis point adjustment could therefore be more pronounced. The RBA, however, is clearly undeterred.

As Lowe noted on Tuesday, prices remain more than 25 per cent higher than before the pandemic, supporting household wealth and spending.

“While the central scenario is for strong household consumption growth this year, the board will be paying close attention to these various influences on consumption as it assesses the appropriate setting of monetary policy,” the governor said.

Crypto conundrum

A few years ago, a gag doing the rounds at banks was that crypto assets were “everything you don’t understand about money combined with everything you don’t understand about computers”.

The joke was repeated last month by the chairman of the Bank for International Settlements – the global standard setter for the prudential regulation of banks – with the rider that our understanding of crypto’s economic and technological dimensions had deepened.

Well, yes. But it’s well over a decade since the global financial crisis and the Basel III reforms to strengthen the financial system are still a work in progress.

As for hauling crypto into the regulatory perimeter, don’t hold your breath.

The BIS set out its initial thinking in a 2019 discussion paper, and followed up last year with a consultation paper which differentiated between three broad types of crypto assets – tokenised versions of traditional assets, stablecoins and all other crypto assets.

It also proposed supervisory guidance to ensure that risks from crypto assets not captured under minimum requirements were assessed, managed and appropriately mitigated.

Finally, there’s been consultation on new disclosure requirements related to banks’ crypto asset exposures, with plans for a further consultation paper in the coming months.

While Australia is part of the global process, local regulators are also working with the Treasury to develop a regulatory model which offers an appropriate level of investor protection.

If the extraordinary pace of crypto market developments highlights anything, it’s the glacial pace of the regulatory response.

The BIS is aware that crypto is a beast that operates according to its own schedule.

In five years, the market has mushroomed from $US16bn ($22.2bn) to $US1.5 trillion, and that’s after the recent crash erased more than half its value.

BIS chairman Pablo Hernandez de Cos, who is governor of the Bank of Spain, said some perspective was needed. Despite the “phenomenal” growth, crypto assets still represented only 1 per cent of global financial assets, and banks’ direct exposures were so far “relatively limited”.

He’s right, but as the Financial Stability Board points out, it’s the trend that matters.

In February, well before the recent crash, the Basel, Switzerland-based FSB, which makes recommendations about the financial system, warned about growing linkages between crypto-asset markets and the regulated financial system.

“Financial stability risks could rapidly escalate, underscoring the need for timely and pre-emptive evaluation of possible policy responses,” it said.

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