Many think the RBA will have to cut rates well before inflation is where it wants it. Here's why (2024)

Days ago, at the start of last week, there was talk of a Reserve Bank rate hike.

Not now, not seriously, although Reserve Bank Governor Michele Bullock said it remained an option on the table when her board met on Tuesday.

In the United States, there's talk of a double cut — two standard-size rate cuts at once — in a bid to stave off recession when the US Fed next meets next month. US markets are pricing in five standard size cuts in the next four months.

In Australia, those arguing that inflation would force our Reserve Bank to push up rates this year have lost one of the planks on which their argument depended.

So despite what the Reserve Bank governor said on Tuesday, here's why so many people expect interest rates will have to come down — possibly sooner than predicted.

Inflation to fall, bounce and fall again

After announcing on Tuesday it had decided to keep the cash rate on hold at 4.35 per cent this month, the bank updated its forecasts. It's now expecting inflation to return to its target band by Christmas.

Australia's inflation rate began the year at 4.1 per cent. It was 3.6 per cent by March, then 3.8 per cent in June, and will be 3 per cent — back to the edge of the Reserve Bank's 2-3 per cent target band — by December, according to the updated forecasts.

Much of the decline in measured inflation will be due to two measures announced in May's federal budget: energy price relief of $300 per household, and a 10 per cent increase in Commonwealth Rent Assistance. The Reserve Bank says their combined effect will be to take 0.60 points off measured inflation.

After the energy price relief ends midway through 2025, the Reserve Bank expects inflation to bounce back up above the target — but only temporarily — before falling back towards it from late 2025.

It expects its preferred measure of underlying inflation, called the "trimmed mean", to continue to fall, as it has since late 2022.

Bullock said she is not yet confident inflation is moving "sustainably" towards the target band. She said the bank was unlikely to cut rates in the "near term", which she said meant this year or early next year.

But many think the bank will have to cut rates well before inflation is where it wants it — and here's why.

The risk of waiting too long on rates

Changes to interest rates take a while to work their way through the economy — as much as a year, and on some estimates as much as two years.

The bank believes that where rates are right now is "restrictive" — meaning at their current level, rates are weighing down on spending and prices.

If it continued to keep rates where they are, and waited until inflation was well within the centre of its target band before it eased, it'd overshoot and push inflation below the band. That would damage the economy for no good reason.

At Tuesday's press conference, Bullock conceded that her talk about no near-term cut was at odds with the expectations of financial markets, and was "not what people want to hear".

But the weight of betting on those markets has become overwhelming.

At 5pm on Monday — ahead of Tuesday's Reserve Bank board meeting — the futures market had more than fully priced in a cut of 0.25 points in the bank's cash rate by November. It had priced in a further cut by February, and another by April, making a total of three before the due date for the federal election in May.

The first cut would save a variable-rate borrower with a $600,000 mortgage $90 per month. The three cuts combined would save $275.

What has changed traders' expectations? What's happening in the United States.

A US recession is more likely

On Friday, the US unemployment rate climbed for the fourth month in a row. The increase, from 4.1 per cent to 4.3 per cent, was enough to fulfil the requirements of what's known as the Sahm Rule, which is said to have predicted every US recession.

That doesn't necessarily mean there will be a recession. But the creator of the rule, former US economist Claudia Sahm, says the risk has "really gone up".

On the back of the news, US shares dived 3 per cent on Friday. On Monday, Australian shares dived 3 per cent, wiping out most of their gains this year.

In Japan, share prices plunged 12 per cent, in part because, alone among major industrial nations, Japan had actually increased its official interest rate.

On Tuesday, share markets recovered a bit — and Japan's recovered a lot. But traders remain skittish. The risk of a recession and all that it entails, including Americans losing jobs and economic growth collapsing, is growing.

How a US recession would hit Australia

As it happens, Australia's Reserve Bank has examined what a US recession would do to conditions in Australia.

A set of studies released under freedom of information rules conclude the direct effects would be limited, as Australia earns much of its money from China. But those effects would be amplified by a hit to consumer confidence and greater financial market uncertainty, which would make it harder for businesses to borrow.

After a year or so, Australia's gross domestic product (GDP) would be 0.5 per cent lower than it would have been.

Given Australia's economy barely grew at all in the first three months of this year, that could be enough to push Australia into a recession as well.

We're already in a personal recession

In its report released on Tuesday, the Reserve Bank makes the point that individual Australians are already in a recession. It says GDP per capita (income per person) has fallen 1.6 per cent since mid-2022.

It also acknowledges that the European Central Bank, the Bank of Canada, the Bank of England and Sweden's Riksbank have all cut rates in response to lower inflation — and that New Zealand's Reserve Bank and the US Fed are preparing to.

The Reserve Bank governor says we won't be joining them soon. But the weight of money on financial markets suggests we will.

Peter Martin is visiting fellow at the Crawford School of Public Policy, Australian National University. This article originally appeared on The Conversation.

Many think the RBA will have to cut rates well before inflation is where it wants it. Here's why (2024)

FAQs

What is the RBA view on inflation? ›

Our goal is to keep annual consumer price inflation between 2 and 3 per cent. The Reserve Bank Board sets monetary policy such that inflation is expected to return to the midpoint of this target.

What is the prediction of the RBA interest rate? ›

The forecasts are conditioned on a path for the cash rate broadly in line with expectations derived from surveys of professional economists and financial market pricing; the cash rate is assumed to remain around its current level of 4.35 per cent until the middle of 2024 before declining to around 3.2 per cent by the ...

What is the RBA decision on May 2024? ›

At its May meeting, the Board decided to hold the cash rate.

Keeping the cash rate at the current level is important to reduce inflationary pressures. This decision supports the objectives of bringing inflation to target and the labour market to levels consistent with full employment.

What will happen with interest rates in Australia? ›

NAB economists predict that the current level of 4.35% will be the cash rate's peak, and they also predict that the first cut is likely to occur in May of 2025, with rates lowering to 4.10%. They anticipate that the cash rate may reduce to 3.60% by the end of 2025.

What is causing inflation in Australia? ›

High inflation outcomes in Australia reflect a range of developments, including: supply issues related to the war in Ukraine; other global supply disruptions resulting from the COVID-19 pandemic; and domestic supply disruptions from poor weather.

Which country has the highest inflation rate? ›

Top 10 Countries with the Highest Inflation Rates (Trading Economics Jan 2022) With an inflation rate that has soared above one million percent in recent years, Venezuela has the highest inflation rate in the world.

Why does RBA raise interest? ›

If inflation is too high, tightening monetary policy (which raises interest rates in the economy) will help to bring inflation back towards the target, but will also be likely to reduce economic growth and put upward pressure on unemployment, all else being equal.

What is causing inflation in Australia in 2024? ›

The latest data shows that the principal driver behind the March quarterly 2024 inflation rate is services inflation, not goods inflation. These include rents (+2.1 per cent for the quarter), secondary education (+6.1 per cent), tertiary education (+6.5 per cent) and medical and hospital services (+2.3 per cent).

Are interest rates expected to go down in 2024? ›

Mortgage rates are currently expected to continue trending down through 2024 and into 2025. The Mortgage Bankers Association thinks that 30-year mortgage rates could fall to 6% in 2025.

What's next for interest rates? ›

If forecasts are correct, this could mean base rate will fall to 4.75 per cent by the end of 2024. Looking further ahead, financial markets are forecasting base rate will fall to around 4 per cent by the end of next year before eventually settling at around 3.5 per cent in 2027.

Will interest rates go down in 2024 in Australia? ›

The next cash rate decision is on 24 September 2024. Official interest rates will come down when inflation reaches the RBA target band of 2% to 3%, most likely in late 2024 to early 2025. Inflation is broadly tracking with the RBA's CPI forecast.

What is the monetary policy in Australia 2024? ›

RBA's Monetary Policy Decision: June 2024. Today, the Reserve Bank of Australia (RBA) announced it's keeping the cash rate at 4.35% and the interest rate it pays on Exchange Settlement balances at 4.25%.

How high could interest rates go in 2025? ›

Mortgage rates are generally expected to fall throughout the rest of 2024 and 2025 as the Federal Reserve starts to lower interest rates. The Mortgage Bankers Association expects the average 30-year mortgage rate to reach 6% by the end of 2025.

What will the interest rate be in Australia in 2025? ›

In the long-term, the Australia Interest Rate is projected to trend around 3.10 percent in 2025 and 2.85 percent in 2026, according to our econometric models. In Australia, interest rates decisions are taken by the Reserve Bank of Australia's Board.

What happens to interest rates in a recession in Australia? ›

When the economy goes into recession it is usual for the government to respond. They spend more and cut interest rates. That's what happened in the second half of 2020, and it drove growth to new highs.

What is the Federal Reserve's stance on inflation? ›

The Federal Open Market Committee (FOMC), which is the part of the Federal Reserve that sets monetary policy, sees 2 percent as the right amount of inflation. The FOMC uses annual changes in the price index for personal consumption expenditures (PCE) as its preferred measure of inflation.

What is the RBI comment on inflation? ›

In the June policy, the monetary authority had pegged the inflation readings at 3.8%, 4.6% and 4.5% respectively. Inflation stood at 4.9% in the first quarter. The RBI today also gave its inflation forecast for the first quarter of the next fiscal year, pegging it at 4.4%.

How does the Reserve Bank control inflation? ›

INFLATION? In 1989, the Reserve Bank was formally given the task of using monetary policy to control inflation. Since 1999, the Bank has done so by setting the 'Official Cash Rate' (OCR) – in other words, by setting the wholesale price of borrowed money.

What is the Federal Reserve measure of inflation? ›

The Fed uses the PCE price index as its main measure of inflation. Its long-run target for inflation is for the PCE price index to increase at an annual rate of 2% over time.

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