After lifting interest rates by a total of 325 basis points since May last year, it may be fair to ask whether the Reserve Bank (RBA) has already done enough to combat inflation.
The bank, however, appears to think not, with its board suggesting earlier this month that further increases are likely to ensure that inflation returns to target.
Drawing upon lessons from the surge in inflation witnessed in the 1970s and 1980s, AMP chief economist Shane Oliver said he believes that the RBA has probably taken sufficient action.
“Inflation expectations are low; there is no evidence of a wage price spiral, notably in Australia; supply bottlenecks, freight costs, and surging money supply which led inflation are now reversing; and high household debt ratios compared to the 1970s should make monetary policy more potent,” he explained in a recent note.
“But the lessons from the 1970s explain why central banks are so fearful of letting inflation get out of control and also the difficult balancing act facing them.”
Dr Oliver also highlighted recent comments made by governor Philip Lowe to the House of Representatives standing committee on economics, pertaining to two key risks the RBA and other central banks are facing.
“One is the risk of not doing enough, which would result in high inflation persisting and then later proving very costly to get down,” the RBA governor said. “The other is the risk that we move too fast, or too far, and that the economy slows by more than is necessary to bring inflation down in a timely way.”
While balancing these two key risks is seen as resulting in a narrow path to low inflation, Dr Oliver opined that determining what is too much or too little tightening is a judgement call.
He believes the RBA’s view has become more hawkish following the December quarter consumer price index (CPI) and that it’s now signalling at least two more rate hikes.
Money markets have also moved to reflect this, he noted, with a consensus emerging that interest rates will continue to rise above 4 per cent.
“Our view is that the RBA risks doing too much given the high vulnerability of a significant minority of indebted Australian households and that the impact of past rate hikes is just being masked by normal lags accentuated by revenge spending associated with reopening,” Dr Oliver said.
“Signs of slowing consumer spending and jobs growth along with there still being no evidence of a wages breakout in Australia are consistent with this.”
Dr Oliver warned that given the current scenario, Australia could see a rerun of the late 1980s and early 1990s during which the country was inadvertently knocked into a deep recession as the lagged impact of rate hikes took time to materialise.
“While we believe rates are close to the top, the RBA’s tough guidance means that the risks are skewed to the upside,” he concluded.
“Further evidence of a slowing consumer and jobs data are necessary to cause the RBA to rethink so upcoming retail sales and jobs data are critical in this.”
