With labour markets having “clearly turned”, attention is now shifting to when global central banks may begin cutting interest rates, according to Ms Ellis.
But the former assistant governor (economic) at the Reserve Bank of Australia (RBA) said that uncertainty remains as to whether Australia’s central bank still has further to go.
“We are often asked why Australia seems likely to be later to reach the rate-cutting phase of the cycle than some other advanced countries. Relatedly, we are also often asked why – even if the RBA were to raise rates further – the peak level seems likely to be materially lower than in the United States, New Zealand and several other peer countries,” she said.
“Part of the reason for the later peak is simply that Australia has been later to the inflation surge and reversal than many other advanced economies.”
Ms Ellis pointed out that Australia was later to reopen following the COVID-19 pandemic and therefore later to observe a mismatch between demand and supply.
According to the Westpac chief economist, Australia can be viewed as being approximately six months behind other countries in its disinflation journey.
“Like the United States earlier in the year, Australia is still in the phase of being surprised how slow services inflation declines at first,” Ms Ellis said.
RBA acting assistant governor (economic) Marion Kohler recently noted that domestically sourced inflation, and particularly services price inflation, have been “widespread and slow to decline”.
The central bank is bracing for a potentially “bumpy” road ahead as it seeks to bring inflation down to its 2 to 3 per cent target, from 5.4 per cent in the September quarter.
Along with Australia’s differing inflation journey, Ms Ellis said that the later expected turning point for interest rates locally is also connected to the “not quite as high for longer” strategy that the RBA appears to have adopted for a number of reasons.
“Foremost among these reasons is the RBA’s stated desire to preserve, as much as possible, the recent gains on unemployment,” Ms Ellis stated.
Australia’s unemployment rate rose 0.2 percentage points to 3.7 per cent in October, but still remains approximately 1.5 percentage points below pre-pandemic levels.
Ms Ellis warned that the RBA’s chosen strategy does come with some risk, given that a longer return to the inflation target raises the possibility that inflation expectations will increase, making it more difficult to bring inflation back down.
“That gamble appears to have paid off so far. Measures of medium-term inflation expectations have largely remained in line with target,” she added.
Backing up its more drawn-out strategy, Ms Ellis suggested that the RBA board is aware that there is not much benefit to a more aggressive path for rates. She noted that the central bank regularly models the likely outcome of different paths for the cash rate.
“It turns out that in the current situation, where much of the inflation surge reflects supply shocks, a more aggressive path does not buy much in terms of an earlier return of inflation to target. It does, however, involve noticeably higher unemployment,” Ms Ellis explained.
The Westpac chief economist said that the success of aggressive monetary tightening is dependent on the central bank being able to reverse course at the right moment.
“Otherwise, you would end up keeping policy tight for too long and undershooting the inflation target for no real benefit. If you are sufficiently humble about your ability to forecast, you would not bank on getting the timing right on that turning point,” she continued.
“That context lends further weight to a strategy more like the one the RBA has chosen. While the February and subsequent meetings are still live, depending on inflation outcomes, it should be understood that the RBA is not following the template set out by other countries.”
