The Reserve Bank of Australia is playing with fire

He writes that the latest interest rate hike is a sign of the Central Bank’s over-action Stephen Koukoulas.

Increasing interest rates to 4.10% at the last meeting is a dangerous game.

This is because there is clear evidence that consumer confidence has collapsed, business sentiment has turned negative, labor force participation has fallen, new home construction has stalled and continues only at a modest level, wage growth has been subdued, and geopolitical strife poses a sharp downside risk to the global economy.

Accountant Jim Chalmers He also stated that a fiscal tightening will be seen in the Budget on May 12, which will further negatively affect the economy in the next year or two.

It’s rare that interest rates have been this high in Australia in the last 14 years.

Indeed, during this time period, only the official cash rate was held steady in the short 13-month period from November 2023 to December 2024. higher and this was when the RBA was struggling with inflation of close to 8%, the unemployment rate was 3.5% and the global economy was gaining a huge boost in the wake of the COVID pandemic.

RBA Governor announcing rate hike Michele Bullock He emphasized that the inflation rate is very high and is likely to remain very high unless ameliorative policies are implemented action receipt.

That’s why interest rates are being increased.

Of course, inflation is above target and the higher oil price will mechanically fuel a higher consumer price index and, for now, a higher inflation rate.

But this risks underestimating the contractionary effects of higher oil prices.

There was a time when a significant increase in oil prices was considered “an event.” tax In other words, higher oil prices were as effective as an interest rate or tax increase in reducing overall demand and lagging inflation in all areas not affected by rising oil prices. This is because demand or use of oil is inelastic; that is, people have to buy it and pay whatever the price, and the ability to change transportation options in the short term is limited.

This is now true. For a homeowner, an extra $40 for a tank of gas means $40 less to spend elsewhere. The Treasury estimates that GDP growth could fall by up to 0.6% due to prolonged high oil prices period.

For the 30 percent of the population with a mortgage loan, the 50 basis point interest rate increase in the last eight weeks will further increase the contraction in cash flow. Growth in household expenditures is certain to be weaker until 2026.

In this discourse on the effects of interest rate increases, the starting point of where the economy is at is vital.

Economic growth will only recover until 2025; it was a welcome five minutes of economic sunshine that surprisingly kept unemployment quite low.

However, the labor market was showing signs of fatigue before the interest rate/oil price double whammy.

Employment growth slowed down, the labor force participation rate fell, while the employment-to-population ratio fell even further. The unemployment rate has been hovering around 4.25% in recent months, down from 3.5% at the low point of the cycle.

As an indication of labor market softness, it is worth noting that if the participation rate remains unchanged rather than falling from last year, the current unemployment rate would be just under 5% rather than 4.3%. This is because large numbers of people are withdrawing from the labor market rather than joining the ranks of the unemployed.

What if the RBA is at fault?

Luckily the RBA’s way isn’t all bad.

If he sees economic growth stalling, unemployment rising and inflation returning quickly to target (which is increasingly likely), he could cut interest rates.

In fact there is a strong whiff of 2007 and 2008 in relation to current RBA action.

At the time, it was marching with gay abandon, with 100 basis point increases between August 2007 and March 2008 as the global financial crisis unfolded. But as the global economy slumped in the wake of the financial fiasco, he cut interest rates by a stunning 425 basis points between September 2008 and April 2009.

It was a remarkable turnaround, but a necessary one.

We could see a carbon copy of such a scenario in the next year or two if growth weakens too much and a recession looms on the horizon.

In the meantime, sit back for a while and prepare for a sharp slowdown in the economy.

Stephen Koukoulas is one of Australia’s most respected economists, the former chief economist of Citibank and senior economic advisor to the Australian Prime Minister. You can follow Stephen on Twitter/X @TheKouk.

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