Reserve Bank accused of getting it wrong on rates – again

The Reserve Bank is being accused by some of the nation’s top economists of putting the employment of hundreds of thousands of Australians at risk by keeping interest rates too high in order to reduce inflation.

Amid suggestions the bank runs the risk of repeating a mistake it made in 2018 and 2019 that forced it to dramatically reverse monetary policy settings, a growing number of analysts believe the RBA has misjudged the impact of the jobs market on the inflation rate.

Reserve Bank governor Michele Bullock says unemployment is still too low to be consistent with steady inflation. A growing number of economists disagree.Credit: Louise Kennerley

The issue goes to the economic concept of the natural rate of unemployment – the level of unemployment consistent with steady inflation.

The bank, which has held inflation within its 2-3 per cent target band for only 15 months over the past 10 years, estimates unemployment needs to be about 4.5 per cent for inflation to be steady. That’s at odds with the federal Treasury, which last month put the safe rate of unemployment around 4.25 per cent.

RBA governor Michele Bullock made clear last week that the bank believed the jobs market was still too strong, describing it as “unusually tight” compared with other countries that have started cutting their key interest rates.

“At present, we judge that conditions in the labour market remain tighter than what would be consistent with low and stable inflation,” she said.

The argument over the trade-off between jobs and inflation flared as parliament finally passed reforms to the RBA including the creation of a separate committee that will set interest rates. The Coalition has accused Treasurer Jim Chalmers of wanting to stack that committee with people who may be “soft” on inflation.

The Reserve Bank’s charter was also changed to narrow its focus to keeping prices stable and delivering full employment.

The bank is forecasting unemployment to rise to 4.5 per cent by mid-2025, helping to bring underlying inflation down to 2.5 per cent by the end of next year.

Unemployment has been steady at about 4.1 per cent since May. During that period, more than 221,000 jobs have been created while the number of people in work or looking for it has climbed to a record high.

A jobless rate of 4.5 per cent would mean an extra 75,000 people out of work.

But ANZ’s head of Australian economics, Adam Boyton, believes unemployment could be around 3.75 per cent and inflation would remain steady. If his analysis is correct, there would be an extra 50,000 people in employment.

Boyton said several indicators, including slowing wages growth and an easing in inflation even as the unemployment rate has remained steady, suggested the Reserve was holding interest rates too high at a potential cost to the overall economy.

“Wages growth could fall a little further, which could mean that inflation declines even more and that would mean the Reserve Bank would have to cut rates,” he said.

“This is an opportunity to get as many Australians in work as possible. We don’t need to accept, at the moment, that we have to get the unemployment rate up higher just so inflation comes down.”

Boyton noted the RBA had gone through the same problem in the period before the COVID-19 pandemic.

In 2018, the RBA consistently argued an interest rate rise was on the horizon. Inflation was tipped to modestly increase as the jobless rate gradually fell to about 5 per cent.

But soon after the 2019 election, the bank halved the official cash rate to what was then a record low of 0.75 per cent as it said unemployment could fall without adding to inflation pressures.

Illustration by Matt Golding

By the end of 2019, inflation was still at 1.9 per cent while unemployment was just starting to edge down but was still at 5.1 per cent.

Gareth Aird, the Commonwealth Bank’s head of Australian economics, said the RBA could allow the unemployment rate to be lower without adding to the nation’s inflation problems.

He said that even as unemployment has remained steady over recent months, overall wage growth – which is on track to be lower than the RBA’s most recent forecasts – has been slowing.

“Wages growth has been moderating since the beginning of the year and is tracking at a pace we believe is consistent with inflation sustainably within the RBA’s 2 to 3 per cent target band,” he said.

“The faster decline in wages growth should give the RBA more confidence that the rate of inflation will continue to decelerate and that upside risks to the inflation outlook are dissipating.”

It’s not just private sector economists who believe the bank is overestimating the inflationary impact of the jobs market.

Employment website Seek says while the overall market is balanced, it is now taking longer for the average jobseeker to find a job and there’s more competition for roles.

“There are still jobs out there for those searching, but they are not as plentiful as they were,” Seek senior economist Blair Chapman said.

The Reserve Bank has also raised concerns about productivity growth across the country, noting that without a lift in productivity it would be difficult for wages to increase, adding to its concerns that low unemployment will keep inflation higher for longer.

Professor Jeff Borland from the University of Melbourne believes unemployment can be lower without adding to inflation pressures.Credit: Jesse Marlow

But labour market expert Jeff Borland said the low nationwide productivity rate was partly due to a decline in the nation’s most productive sector, mining. Even a small drop-off in mining has a large impact on the nation’s overall productivity level.

Borland said those industries with large increases in hours worked, such as human services and mining, had experienced the biggest slips in productivity, suggesting they were yet to train new staff or invest in new equipment that would lift overall production.

Borland, who thinks unemployment could safely fall to between 3.5 per cent and 4 per cent, said there was a trade-off between inflation and a tight jobs market.

“I’m not arguing that we should be actively pushing towards that low point, but it seems like unemployment could be a bit lower,” he said.

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