One of the big themes to emerge from my recent conversations with customers and officials in the US and Europe was that the effectiveness of monetary policy in curbing inflation has been disappointing.
Economic trends that emerged from the pandemic, including tight labour markets, the accumulation of excess savings, as well as a high level of fixed rate loans in the system, have combined to dull the impact of higher interest rates in many jurisdictions.
You can probably include the RBA in that camp, with the Governor’s concerns about inflation expectations and the threat of wage price spirals putting interest rate hikes firmly back on the agenda here.
Increases in the cash rate in May and June, after a pause in April, came as somewhat of a surprise, with the RBA’s priorities clearly shifting back on to inflation risks, rather than maintaining the benefits to the jobs market from the post-COVID period.
For that reason, we now think it’s very likely the RBA delivers another quarter percentage point hike in the cash rate in July. And following the May jobs report, which indicated that the labour market remains incredibly tight, we expect there will be a further hike at the August Board meeting, pushing the rate up to 4.6 per cent.
The knock-on effect of these hikes is that it’s likely to push back the start of interest rate cuts. We’re now pencilling in May 2024 for the first cut, pushed back from our previous expectation for February.
We’ve also downgraded our forecast for economic growth in the current year and next, reflecting the likelihood that interest rates stay higher for longer. Growth in 2023 is now seen at just 0.6 per cent, down from 1 per cent previously, and at 1 per cent in 2024, down from 1.5 per cent.
At this stage, we’re not expecting a technical recession – defined by two consecutive quarters of negative growth, but we are likely to see a per capita recession in 2023 and 2024, where population growth exceeds economic growth.
All this has negative implications for the labour market, and we’re expecting that the unemployment rate, which we previously predicted would reach 5 per cent at the end of 2024, will now rise to 5.3 per cent in line with the weaker growth outlook.
So, the Australian economy is in for some difficult times ahead, particularly around the weak consumer. That will be the key theme for the next couple of years as this long run of interest rate hikes really starts to bite.