Inflation in Australia, although past its peak, remains persistently high, driving the need for further hikes in the year ahead, according to the International Monetary Fund (IMF).
In its latest report on Australia released late last week, the fund posited a further tightening cycle in the absence of supportive alternative policies.
It said short-term policies should focus on navigating the economy to a soft landing, by bringing inflation back to target, while maintaining financial stability.
“Higher policy rates have primarily affected lower income households with mortgages (around 40 per cent of households), adding to their hardship amidst high inflation and cost-of-living crisis. Businesses have felt less of an impact as evidenced by the still healthy credit conditions, and households who own their homes are set to benefit from a recovery in the housing prices,” the IMF stated.
“Alternate tools, such as fiscal policy, must ensure that other sectors of the economy do their part. Going forward, a careful coordination of policies will be key to ensuring an equitable distribution of the burden of adjustment.”
Fiscal policy, the fund explained, must “strike an appropriate balance” between supporting monetary policy by not adding to inflation pressures in the near term and the necessary structural transformation over the long term.
In that context, the IMF said it sees merit in a “comprehensive tax reform” and highlighted that rebalancing the tax system from direct to indirect taxes, while addressing regressive impacts, would promote greater efficiency.
“Comprehensive tax reforms remain indispensable to long-term fiscal sustainability and productivity,” the fund said.
“High reliance on direct taxation is amplifying challenges of financing health and aged care as population ageing lowers the share of workers and declining productivity growth puts a drag on wages.”
Referencing the government’s 2023 Intergenerational Report, the IMF underscored the growing dependence on bracket creep in the absence of tax reforms.
“Addressing these challenges heads on will avoid costly delays in tax reforms needed for sustained and shared prosperity.”
Inflation target still a ways off
Ultimately, the IMF believes inflation is not likely to return to the RBA’s target range until 2026.
According to the latest monthly consumer price index (CPI) data, inflation rose by 4.3 per cent in the 12 months to November, down from the 4.9 per cent rise in October and marked the smallest annual increase since January 2022.
The most significant contributors to the November annual increase were housing (+6.6 per cent), food and non-alcoholic beverages (+4.6 per cent), insurance and financial services (+8.8 per cent), and alcohol and tobacco (+6.4 per cent).
The IMF observed that while external price pressures have abated, leading to an easing in goods inflation, “persistence in non-tradeable prices driven by demand pressures will keep inflation elevated”.
“A positive output gap, amidst tight labour markets, would exert price pressures in the near term,” it said.
“In addition, while real wage growth has been negative, the pick-up recorded in recent quarters could delay disinflation. The recent strong net migration inflows are expected to further alleviate labour market tightness but add to demand, especially in the rental market.”
It forecast economic growth to further decelerate in the near term, dropping to some 1.8 per cent year-on-year in 2023, and 1.4 per cent year-on-year in 2024.
“Faltering private consumption would continue to put a drag on the economy, as households with mortgages bear the brunt of higher interest rates, amidst lower real wages and depleting savings,” the IMF said.
Earlier this month, following the release of the latest CPI data, AMP said it expects the first rate cut in June with the cash rate falling to 3.6 per cent by year end.
“Much has been said about higher Australian inflation data relative to our global peers. However, Australian inflation peaked three to six months after our major peers, so it’s only natural that the decline in inflation is also occurring later than our peers – and in fact, it is still following the same trajectory,” said AMP’s chief economist, Shane Oliver.
“We expect that inflation for December quarter 2023 will be comfortably under the RBA forecast of 4.5 per cent YoY, consistent with it leaving the cash rate on hold at the next RBA meeting and rate cuts from mid-year.”