Deutsche Bank said in its most recent research paper that the Reserve Bank’s (RBA) most recent inflation outlook “looks too conservative”.
Earlier this week, the RBA announced its revised inflation forecast which points to a drop in inflation to 3.3 per cent (instead of the earlier predicted 3.9 per cent) by June.
From there, however, the RBA expects inflation to ease at a snail’s pace, reaching 3.2 in December and 3.1 per cent six months later. By the end of 2025, inflation is expected to finally hit the target band by reducing to 2.8 per cent, before dropping further to 2.6 in June 2026.
The financial institution’s chief economist for Australia, Phil O’Donaghoe, believes the RBA is exercising too much caution despite recent history suggesting that inflation could actually drop “much more quickly” than the bank anticipates.
“That would mean RBA should be cutting more and earlier, rather than less and later,” Mr O’Donaghoe told InvestorDaily.
Looking back at “one of the RBA’s biggest near-term forecast misses on record” – the bank’s prediction that inflation would rise by half a percentage point to June 2022 versus its actual 2.25 percentage point lift – the economist said the central bank’s forecast needs to be “more adaptive to hard data points”.
The key question now, he opined, is whether the same lesson is about to be learned again, only this time in the other direction.
“Time will tell, meaning upcoming data points are crucial. But history suggests the RBA’s latest forecasts are at risk of proving too conservative,” said Mr O’Donaghoe.
“The RBA suggested that a ‘further increase in interest rates cannot be ruled out’, we would instead argue more emphatically that a May rate cut cannot be ruled out. Recent data could well mark a turning point. And at turning points, it pays to be nimble.”
Economists are now broadly in agreement that the RBA will cut rates this year on the back of favourable inflation expectations, however, some are more optimistic than others.
In the more optimistic camp is AMP’s chief economist, Shane Oliver, who believes the RBA will adopt an easing bias by the May meeting, before pivoting to rate cuts mid-year.
“Our assessment remains that the combination of weaker growth and a faster fall in inflation than the RBA currently expects will ultimately force its hand and we continue to see it cutting rates from mid-year with three 0.25 per cent rate cuts by year end, taking the cash rate down to 3.6 per cent by December,” Dr Oliver said earlier this week.
Speaking to InvestorDaily on Thursday, Dr Oliver said he sees inflation falling to 2.9 per cent year-on-year by the September quarter this year and 2.6 per cent by the June quarter next year, both of which are a year ahead of RBA’s forecasts.
His assessment of the RBA’s forecast is broadly in line with Mr O’Donaghoe’s sentiment, with Dr Oliver also describing it as rather “cautious”. The risk, he noted, is that the RBA leaves rates too high for too long, inversing their mistake from two years ago when they let rates remain too low for too long.
“The outcome could end up being a sharper-than-necessary fall in economy and higher-than-expected unemployment which would result in inflation falling back below the RBA’s target,” said Dr Oliver.
“Of course, at present, it probably feels that with the economy still growing and stronger than feared, it has a bit more flexibility to wait for more evidence to be able to get confidence that inflation is sustainably heading back to target and so help avoid the risk of cutting too early.”
Earlier this week, the RBA maintained its hawkish stance, leaving the door open for future rate hikes.
“There’s more work to do,” RBA governor Michele Bullock said, after the central bank held rates at 4.35 per cent.
Ms Bullock is not fazed by market pricing, noting on Tuesday that the RBA doesn’t think of market pricing as “being a forecast of our own cash rate”.
“Markets will make their own decision and they are putting their money where their mouth is on those sorts of things. But we’re not driven by market pricing. What’s important for us is looking at the economic data.”
The economic data is currently suggesting robustness and resilience despite 13 rate hikes since May 2022. However, Australia’s productivity is often cited as a major challenge, with the country’s Productivity Commission last year raising alarm bells and urging an increase in investment and innovation to ensure growth.
According to the RBA’s latest forecast, GDP growth should come in at 1.8 per cent at the end of this year and 2.3 per cent at the end of 2025.
