The only reason the RBA will cut rates next year starts with R

But core inflation is likely to remain stubbornly and uncomfortably above target.

One plausible scenario is that local inflation falls from the nearly 8 percent forecast to, say, around 4 percent, over the next year or so.

But inflation-fighting central banks like the Reserve Bank of Australia will need to “squeeze out” the bottom line of price pressures over the next couple of years to keep inflation expectations at bay from moving companies. costs and workers claiming wages. .

The only reason to lower rates

The only way the US Federal Reserve and RBA will cut interest rates next year is by inadvertently imposing a harsh recession, a scenario they are trying to avoid by slipping through the proverbial “narrow window”.

Even if there is a mild recession, there is no guarantee that the Fed and RBA will cut rates unless inflation is cooling rapidly and they are confident that core inflation will return to their respective 2 percent and 2 percent targets. 3 percent. .

Money markets are pricing in a maximum RBA cash rate above 4 percent.

While that seems overly aggressive, the money market has been more accurate than most forecasters during the pandemic, so it should not be dismissed lightly.

The RBA cash rate is expected to be above 3 percent until next year.

Strong retail spending data for July shows that the string of rate increases since May has yet to dampen buyer enthusiasm. Gerry Harvey of Harvey Norman and Rob Scott of Wesfarmers continue to see demand for healthy consumption.

Another half percentage point cash rate hike to 2.35 percent next Tuesday looks assured.

With high inflation and full employment now driving a noticeable rise in wages in the second half of the year, the RBA will need to move the cash rate above the so-called neutral rate into tightening territory to cool consumer spending. and relieve the heat. of the stretched labor market.

The dilemma is that the RBA, like everyone else, has no idea what the neutral rate is, the rate at which policy is neither stimulative nor contractionary.

Then-US Federal Reserve Chairman Alan Greenspan said in the early 2000s that “it’s very hard to know where the so-called neutral rate is.”

“But we’ll probably know when we’re there because we’ll see a certain degree of balance, which we haven’t seen before, which would suggest we’re somewhere very close to where that is.”

The RBA will not really know what the approximate neutral rate is until after the event.

flying blind

The full effects of monetary policy take between 12 and 18 months to manifest. He’s flying blind with aggressive (but necessary) rate raises.

RBA Governor Philip Lowe has talked about a neutral rate of “at least” 2.5 percent, but he doesn’t want people to give him too much credibility because the central bank doesn’t have much confidence.

The rate of “at least” 2.5 percent is just a default consequence of being in the middle of the inflation target and Lowe’s expectation that the actual (inflation-adjusted) rate is zero or more.

A 2017 RBA document suggested that real the neutral rate was around 1 per cent, implying a nominal neutral rate of around 3.5 per cent.

That’s negated labor productivity growth of 1 percent, a result Australia has struggled to achieve for much of the last decade.

This week’s Jobs and Skills Summit should set a serious agenda for increasing productivity and raising real wages.

The absence of the Chairman of the Productivity Commission, Michael Brennan, from the invited list of 142 participants is curious, given that the Albanian government repeatedly talks about productivity.

The summit seems poised to deliver some quick and easy solutions to increasing skilled immigration, more investment in skills and training, and a future path for industrial relations reforms.

A looser overall improvement test in the business bargaining framework would allow for more productivity-enhancing EBAs to be finalized, rather than industry arbitrator and third-party unions blocking deals that sometimes have 80 percent support at 90 percent of the staff.

But these aforementioned areas will not be enough to revive the low productivity growth of 50 years.

Tax Reform

After the jobs summit, there needs to be a serious reckoning about reforming a tax system that penalizes workers and allows the asset-rich to travel for free, driving competition against established companies and more efficiency through data and technology in the government-dominated sectors of aged care, health, disability care, and education.

Higher productivity is the only way workers will feel the benefits of real wage increases.

If all we get are nominal wage increases adding to inflationary pressures, the RBA will have no choice but to tighten monetary policy further.

Australia does not currently have a wage-price spiral like the US. Persistent wage pressure could emerge.

Additionally, Australian households have much stronger balance sheets than their counterparts in the US and Europe, where household savings have returned to pre-COVID levels.

The resilience of local households will be tested by rising interest rates that will cause housing prices to fall.

But the RBA will want to be sure that inflation is returning to target before giving up the fight against inflation prematurely.

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