Reserve Bank cautioned to go slowly on interest rate cuts

The OECD has cautioned the Reserve Bank against cutting official interest rates too quickly as the central bank prepares to overhaul its key economic forecasts that are expected to show the nation’s inflation pressures are easing.

Ahead of the conclusion of the RBA board’s first-ever two-day meeting to determine interest rate settings, the Organisation for Economic Co-operation and Development used its interim economic outlook to argue the world’s central banks should not be complacent about the threat of ongoing inflation.

RBA governor Michele Bullock will front her first press conference to explain the bank’s economic outlook on Tuesday.Credit: Mick Tsikas

The Reserve Bank board started its meeting on Monday, and a decision on the cash rate, which has been at 4.35 per cent since November, is to be announced on Tuesday afternoon. It will be followed by a press conference by governor Michele Bullock, her first in charge of the bank.

The two-day meeting, plus a press conference and the release of the RBA’s quarterly economic outlook, form part of the overhaul of the bank recommended by last year’s independent inquiry.

Analysts and financial markets expect the bank to hold interest rates steady but revamp its key economic forecasts.

The December-quarter consumer price index showed inflation at a two-year low of 4.1 per cent, well below the Reserve Bank’s most recent forecast in early November. The bank had expected inflation would not be back within its 2-3 per cent target band until the end of 2025, but this is likely to be brought forward in its new forecasts to be released on Tuesday.

Financial markets are pricing in an interest rate cut by July because of the improving inflation outlook. Economists are more circumspect, believing the RBA will cut the cash rate twice in the second half of the year.

But the OECD said while the inflation outlook had improved, central banks needed to keep monetary policy tight to ensure prices remained in check.

“Monetary policy needs to remain prudent to ensure that underlying inflationary pressures are durably contained,” it said.

“Scope exists to lower policy interest rates as inflation declines, but the policy stance should remain restrictive in most major economies for some time.”

But it also noted inflation had fallen faster than expected in most countries, adding that the full impact of interest rate increases had yet to feed through economies.

The OECD’s outlook for the Australian economy over this year and next has not changed from its November report.

It is forecasting Australian GDP to expand by 1.4 per cent this year and 2.1 per cent in 2025, making it one of the fastest-growing developed countries monitored by the OECD.

The organisation is expecting Australia’s inflation rate to fall to 3.5 per cent this year and 2.8 per cent in 2025, well above other developed nations.

In an examination of the factors contributing to inflation in major economies, the OECD estimates more than half of Australia’s inflation in 2023 was caused by supply-side factors. A third was put down to demand while the rest was described as “ambiguous”.

Australia’s inflation profile was similar to those of France (the world’s seventh-largest economy) and Britain (sixth largest). Domestic demand was a bigger driver of inflation in the United States while supply-side issues were key issues in both Canada and South Korea.

The Reserve Bank has been forecasting the jobs market to slow in response to higher interest rates. The national jobless rate rose from 3.5 per cent to 3.9 per cent through the second half of 2023.

The ANZ-Indeed’s closely watched measure of job advertisements, released on Monday, showed a lift of 1.7 per cent in January after a 0.6 per cent improvement in December. Despite the increase, it is still 13 per cent down over the year although at a historically high level.

Indeed senior economist Callam Pickering said although the figures suggested the job market was showing resilience under the weight of higher interest rates, the overall economy was slowing.

“Our view is that economic conditions will remain subdued this year, particularly within the household sector, and that should prove sufficient to bring inflation back to target,” he said.

“And that’s likely to happen well ahead of the RBA’s current forecasts. Rate cuts in the second half of the year are increasingly plausible and there will be lots of discussion to that effect.”

Cut through the noise of federal politics with news, views and expert analysis. Subscribers can sign up to our weekly Inside Politics newsletter.