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There\u2019s nothing the media likes more than an interest rate rise on Melbourne Cup day. It\u2019s surprising how often it\u2019s happened, and many in the financial markets have convinced themselves that\u2019s what we\u2019ll get next Tuesday. And the good news is that, despite the radical reform of moving to a mere eight board meetings a year, the Reserve Bank has ensured that meetings on cup day will continue.<\/p>\n
What I\u2019m not sure of is whether, if we do get a rate rise next week, it will be happening by accident or design. In central banking, getting your timing right is just as important as it is in a comedy routine.<\/p>\n
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Last week new Reserve Bank governor Michele Bullock used her first big speech to make sure everyone noticed her bulging anti-inflation muscles.<\/span>Credit: <\/span>Bloomberg<\/cite><\/p>\n It was no surprise last week when new Reserve Bank governor Michele Bullock used her first big speech to make sure everyone noticed her bulging anti-inflation muscles. \u201cThere are risks that could see inflation return to target more slowly than currently forecast,\u201d she warned.<\/p>\n \u201cThe board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation,\u201d she said. She added some qualifications but, predictably, neither the markets nor the media took much notice of them.<\/p>\n Any new governor would have said the same in their first speech. Trouble is, her tough statement about not being willing to return to the 2 to 3 per cent inflation target \u201cmore slowly than currently forecast\u201d came just the day before publication of the consumer price index for the September quarter.<\/p>\n And while it showed the annual rate of inflation continuing to fall from its peak of 7.8 per cent at the end of last year to 5.4 per cent nine months later, it also showed the quarterly<\/em> inflation figure rising from 0.8 per cent to 1.2 per cent.<\/p>\n When nervous-nelly governors decide to err on the safe side, they\u2019re deciding to beat young home buyers even further into the ground.<\/p>\n This was 0.2 percentage points or so higher than the markets \u2013 and, they calculate, the Reserve \u2013 were expecting. Bingo! Rate rise a dead cert. All the big four banks are laying their bets accordingly.<\/p>\n But the main reason for the slightly higher number was a rise in petrol prices, which contributed 0.25 percentage points of the 1.2 per cent. This rise comes from insufficient supply: the higher world price of oil, forced up the OPEC oil cartel and others trying to increase the price by restricting their supply.<\/p>\n It does not<\/em> come from excessive Australian demand \u2013 which is the one factor the Reserve can moderate by increasing interest rates. Similarly, the next-biggest price increases, for newly-built homes (imported building materials), rents (surge in immigration) and electricity (Ukraine war) aren\u2019t caused by anything a rate rise can fix.<\/p>\n The rise in petrol prices comes from insufficient supply, not Australian demand.<\/span>Credit: <\/span>Dion Georgopoulos<\/cite><\/p>\n So I think the case for yet another rate rise is weak. As Bullock clearly demonstrated elsewhere in her speech, the Reserve\u2019s single, crude instrument, raising interest rates, delivers most of its punishment to the quarter or so of households with big<\/em> mortgages.<\/p>\n Too many of these people are really hurting, and the full hurt from rate rises already made has yet to be felt. The economy is slowing, consumer spending is hardly growing, real income per person is falling.<\/p>\n And, as Treasury secretary Dr Steven Kennedy noted in a speech last week, last financial year\u2019s budget surplus of $22 billion shows the budget\u2019s \u201cautomatic stabilisers\u201d are working hard to help the Reserve restrain demand \u2013 a truth that\u2019s been completely missing from the Reserve\u2019s commentary. That\u2019s gratitude for you.<\/p>\n But if, having thought hard about such a small change to the \u201coutlook for inflation\u201d, Bullock decides a further rate rise isn\u2019t warranted, what are the money market punters (and I do mean people making bets) going to think, considering all her chest-beating? That she speaks big but carries a soft stick?<\/p>\n There are a few things she \u2013 and her urgers in the financial markets (most of whom have never in their lives had reason to worry about the cost of living) \u2013 need to remember.<\/p>\n First, at this late stage in the game, we really are into fine-tuning. And acting because a revised forecast means we\u2019ll return to target later than we had expected suggests you\u2019ve forgotten what every governor needs always to remember: as with all economists, the Reserve\u2019s forecasts are more likely to be wrong than right.<\/p>\n They can be wrong by a lot or wrong by a little. Worst, they can prove too optimistic or too pessimistic. If your previous forecast was wrong, what makes you so sure your next one will be right? When it comes to forecasts, the person making the actual decisions needs to be the biggest sceptic.<\/p>\n Second, the Reserve\u2019s previous forecast was for inflation to be back to the top of the target range by the first half of 2025. If its latest forecast pushes that out to the second half, what\u2019s so terrible about that? How much extra pain for young people with huge mortgages does that justify?<\/p>\n Ah, says the Reserve, the reason we can\u2019t wait too long to get inflation back to target is that, the longer we leave it, the greater the risk that business\u2019 and workers\u2019 expected rate of inflation rises above the target range.<\/p>\n If that happened, we\u2019d need much higher interest rates and much more pain to get expectations back down to the only range we\u2019ve decided is acceptable.<\/p>\n This is true in principle but, in practice, it\u2019s mere speculation. The fact is, the world\u2019s central bankers have no hard evidence on how long it takes for inflation expectations to adjust \u2013 a few years or a few decades.<\/p>\n I\u2019m old enough to remember that when inflation returned, in the late-1960s and early-\u201970s, it took a decade or two for expectations to adjust. The smarties used to advise youngsters to borrow as much as anyone would lend them. Why? Because real interest rates were negative.<\/p>\n But when a decade or two of tough inflation fighting eventually got expectations down to what became the target range, after the recession of the early \u201990s, they\u2019ve shown zero sign of moving for 30 years. Not even during the present inflation surge.<\/p>\n So when nervous-nelly governors decide to err on the safe side, they\u2019re deciding to beat young home buyers even further into the ground. Either sell your house or starve your kids.<\/p>\n Finally, in her answers to questions last week, Bullock implied that the risk of rising inflation expectations was now so great that the Reserve could no longer afford the nicety of distinguishing between supply-side shocks and price rises driven by excessive demand.<\/p>\n Whatever the cause, continuing delay in getting inflation back to target presented such a threat to expectations that rates would have to keep rising regardless.<\/p>\n This means that if our return to target is delayed by supply-side problems \u2013 mismatches in the transition to renewable energy, leaps in meat and veg prices caused by extreme weather, or higher oil prices caused by worsening conflict in the Middle East \u2013 the home buyers cop it.<\/p>\n In this era of continuing supply shocks, failure to distinguish between the causes of price rises would be a recipe for deep recession. The Reserve\u2019s professed \u201cdual mandate\u201d \u2013 full employment \u2013 would be out the window.<\/p>\n<\/p>\n