A 5-4 vote says everything about the Reserve Bank’s dilemma
Five members of the Federal Reserve’s monetary policy committee are currently worried about inflation. The four are more concerned about where the economy will be in a few weeks.
That’s the simple takeaway from the bank’s split decision on Tuesday to raise the cash rate by a quarter point.
But there was one person who didn’t vote one way or the other, and who will have a big say in the future direction of interest rates in this country and the debate between inflation hawks and economic doves: Donald Trump.
After Israel and the USA launched an attack on Iran two weeks ago, expectations for an interest rate increase increased further. Investors and economists, already concerned about domestic inflation and a tight employment market, believed that the war and its impact on global oil prices (among other things) would force the Reserve’s hand.
Market pricing has increased from about a 15 percent chance of a rate increase to a three-quarter chance.
The biggest concern was what impact the war would have on inflation, driving oil prices above US$100, with flow-on effects in areas such as fertilizer and international travel.
These concerns supported the votes of five board members who supported the rate hike.
However, high oil prices are not due to increased demand, which is the normal driver of inflation. This is driven by questions about supply, which is effectively in the hands of Iran and its network of drone operators who threaten to inflict hell on any ship passing through the Strait of Hormuz.
High price oil will slow down the economy. However, the extent of this slowdown is not in the hands of the Central Bank or the four board members who voted against the interest rate increase.
This dovetails with Trump and his readiness to wage war against a country that wants to hold the United States and, in effect, the developed world to ransom.
Bank executive Michele Bullock described the split vote as simply an argument about timing. The bank’s board agreed that interest rates should rise; It was just a matter of whether debtors would be hit this week or in early May.
This would make perfect sense, except for the fact that there is a lot of uncertainty about how Trump’s war will affect the global and domestic economy.
Just a year ago, the bank was so ambivalent about the effects of Trump’s tariff war that it debated a half-point rate cut, then was surprised not to cut rates in July and cut rates in August.
Economic uncertainty has not improved since then.
The bank fears that high inflation will fuel expectations among workers, shoppers and businesses that inflation will be permanent. In central banking jargon, there are concerns that “inflation expectations will not be stabilized”.
Despite the turmoil in the Middle East, the rate hike is a big signal to consumers and businesses that the Federal Reserve is dead serious about getting inflation under control.
But just hours before the bank’s announcement, the ANZ-Melbourne Institute’s measure of consumer confidence was released. This showed that consumer sentiment had fallen back to when the Morrison government closed the country’s borders to prevent the spread of Covid-19.
The war in Iran, the hit to oil prices and the flow-on effect of inflation and the RBA’s rate settings mean shoppers are now as scared as when a new virus spread around the world and killed thousands.
No one can argue that this will lead to a further burst of inflation.
The 5-4 vote reflects the tough decision the bank faces and the risks involved.
Another rise in oil prices (some analysts say US$200 per barrel is out of the question) and a prolongation of the war cannot be ruled out.
The combination of eye-wateringly high oil prices and high interest rates could easily force the bank to go into reverse.
By acting now, the bank has given itself some breathing room. Expectations for a rate hike in May fell sharply after investors saw the split vote and heard Bullock’s statement.
He now has to hope that Trump will find a solution to the war in the Middle East, that Treasury Secretary Jim Chalmers will deliver a budget with significant savings, an efficiency package and tax reform, and that consumers will rein in their spending; But this is not enough to put the economy into a tailspin.
Simple.
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Shane Wright is senior economic correspondent for The Age and The Sydney Morning Herald.Connect with: X or email.
