Australia facing prolonged lag in interest rate change

The Reserve Bank of Australia (RBA) is likely to hold off on any “downward adjustment” to interest rates in the near term, bucking the policy rate slide in the rest of the developed world, as persistently “sticky” inflation and a still robust labour market offer little impetus to change course, says a leading investment analyst.

An expected loosening of monetary policy will lag someway behind most other developed countries, writes GSFM investment strategist Stephen Miller in a recent op-ed, with policy rate change not expected until at least early to mid-2025.

The RBA in its Tuesday Board meeting opted to maintain Australia’s cash rate at 4.35% – a rate unchanged in nearly 11 months. Despite a “substantial fall” in inflation since the 2022 peak (7.8%), the current trimmed mean rate of 3.9% is, the RBA reasoned, still well above its target range (2-3%).

“In year-ended terms, underlying inflation has been above the midpoint of the target for 11 consecutive quarters and has fallen very little over the past year,” the Reserve wrote in its 24 September Monetary Policy Decision statement.

A return to target is expected no earlier than 2026, with RBA Governor Michelle Bullock suggesting no interest rate cuts “in the near term”.

Both the US and New Zealand central banks recently announced their first policy rate cuts in more than four years – the Fed by 0.5%, the RBNZ by a more modest 0.25%. These rate changes, however, came off a markedly higher policy rate base of 5.5%.

This point was acknowledged by Miller, noting the RBA’s more restrained approach in comparison with other developed economies in cooling the post-Covid spending boom.

“Where the RBA has differed from other developed country central banks, is that it has shown a reluctance to raise rates as far and as fast,” he said.

“The consequence has been relatively lower policy interest rates than most other developed countries, but relatively better labour market outcomes.”

The downside to the RBA’s more restrained response, however, has been relatively “stickier inflation”.

For Miller, the RBA’s recent policy rate decision and justifications were sound, with Governor Bullock “[striking] the right tone in her press conference”, as well as being “careful to downplay the prospect of any near-term policy rate cut”.

“[In] the RBA view, demand is still running ahead of supply, making for “sticky” inflation and until the Board is confident that state of excess demand will be resolved, current policy settings will remain.”

RBA decision ‘vindicated’, but must persist

According to Miller, recent economic developments since the last RBA meeting have by and large vindicated its inflation-busting ‘experiment’.

“That is a point that is lost by the at times ill-informed, even febrile, commentary from current and former politicians,” he said.

However, the RBA’s continued insistence on “sharper deterioration in the labour market” as a result of slower than expected uptick in household consumption, is not borne out in evidence, according to Miller.

Furthermore, he added, while the August monthly CPI indicator showed a headline inflation rate at 2.7 per cent (within the 2-3 per cent target band), this “does not represent, in the Board parlance, a ‘sustainable’ return of inflation to target”.

“Therefore, unless there is either a wholly unanticipated, and at this stage unlikely deceleration in inflation, that is at a pace greater than revealed by the most recently issued RBA forecasts, or any unlikely and significant deterioration in the labour market between now and the November meeting, any RBA policy rate reduction this year is a remote prospect.”

Miller concluded: “Absent a recessionary lurch in the global economy and/or a ‘sharper deterioration’ in the labour market, it remains difficult to see a policy rate reduction before February 2025.”