Get ready for another hit.
When the heavyweights of the Reserve Bank gather around the board table at Martin Place tomorrow, the question will not be whether to raise rates, but by how much.
The consensus is that we will be hit by a fourth consecutive double hike, although some forecasters, such as Saul Eslake, believe that the RBA will start to moderate the rises this month, reducing them to increases of 0.25 percentage points.
A latecomer to the rate hike party, the Reserve Bank is coming under increasing pressure from outside forces to maintain momentum, especially as U.S. Federal Reserve boss Jerome Powell said he its intention to continue the fight against inflation a little over a week ago.
Since that speech, the already capricious financial markets have turned around.
Just when they thought the worst might be behind us, they were forced to reevaluate their forecasts of where interest rates would top, with much higher forecasts sending stocks and bonds tumbling. .
Last week, Wall Street lost about 7% while our market was down about 4% with some particularly heavy selling days.
Just at the right time, the decline of our housing market accelerated last month, falling at the fastest rate in 39 years. It is now widespread across the country, with regions heading south and all capital cities except Darwin in decline.
Asset markets are down globally and central banks, led by the US Fed, don’t seem too worried.
This change in attitude is significant. After spending the past 20 years jumping to the defense of financial and housing markets, cutting rates at the slightest sign of trouble, the world’s largest central bank has suddenly decided to play hardball with a firm resolve to kill inflation. first and worry about recessions later. .
It’s too early to tell if it’s going too strong. But his actions will have repercussions globally, including here.
How far will the RBA hikes go?
Another double hike tomorrow will take the official exchange rate to 2.35%. Since a standing start at a touch above zero in May, the pace of rate hikes has been incredible, unlike anything we’ve seen in decades.
If the money markets are to be believed, the RBA will quickly hit 4%, although the speed at which the money markets are changing their forecasts is breathtaking.
The most sensible commentators, including Eslake and Gareth Aird of the Commonwealth Bank, think we have seen the worst, that although there are more rate hikes to come, the pace will slow considerably.
There is a simple explanation for their thinking. It takes time for the full effect of interest rate changes to be felt. This is called the lagged effect.
Although we have seen a decline in house prices as banks are no longer willing to lend the kind of money they used to be, there have been few early signs of a slowdown in spending. Household.
One of the reasons is that banks are slow to impose rate changes on their customers. Another is that it takes some time for consumers to start cutting back on their spending. The tide turns slowly at first before receding at a faster rate.
There are also other factors. A large number of new entrants to the housing market have taken fixed rate mortgages, which will unwind over the next 18 months, so the impact of rising interest rates has effectively been delayed.
The RBA is now at the point where it needs to tread carefully. If he continues to criticize mortgage holders and business owners with rapid increases in the fire rate, he could find by Christmas that he has exceeded the bar and may have to back down.
It would be a disaster. The idea behind monetary policy is to keep the economy on a balanced keel, add a touch of throttle when things are slowing down, and gently apply the brakes when it looks like the economy is overheating.
Pressing the brakes, as is the case now, is a dangerous tactic, which could easily go wrong. And let’s face it, the RBA hasn’t had a great record lately when it comes to ring picking.
The monetary puzzle
The Aussie dollar was like a jack in the box late, bouncing between US72c and below US68c.
The slowdown in China is a factor. Iron ore prices have collapsed in recent months.
But the biggest influence has been the strength of the greenback. As the Fed raised interest rates, the US dollar soared. In June, America hit borrowers with a triple hike, pushing the spot rate to 2.5%.
The next US hike could most likely be another triple whammy, pushing rates up to 3.25%. Such a move would ignite a fire under the greenback and see the Australian dollar sink.
This is something that would seriously concern the RBA. A weaker currency is inflationary because it costs more to import goods. Given that the current objective is to kill inflation, the temptation within Martin Place would be to ensure that our currency does not weaken too much.
There is a danger that the RBA will get swept up in the vortex and push rates higher than they should just to support the currency.
Those considering a stay abroad may disagree, but a weak currency isn’t all that bad.
It makes local industry more competitive and boosts exports, which helps reduce unemployment.
Can we avoid recession and maintain full employment?
If there is a real positive point for the economy at the moment, it is that of employment.
With the unemployment rate at just 3.4% and wage growth well below that of the United States, there is a real feeling that we could have a unique opportunity to return to the era of “full employment” in ‘after war.
For half a century, it was believed that we needed a pool of unemployed to contain inflation. It’s a theory that evolved in the wake of soaring inflation in the 1970s, that around 5% of the labor force needed to be out of work to ensure a plentiful supply of workers.
The practice is so steeped in economic theory that it even has its own acronym. This is called the NAIRU, the unemployment rate without accelerating inflation.
The theoretical rate has fluctuated over the years and more recently it has fallen. From 5 percent, it was lowered into the fours a few years ago and is now in the threes.
It is highly uncertain whether this trend can be sustained, as the intention of rapid rate hikes is to strangle growth and depress demand, which in turn has an impact on employment.
The economy is already slowing rapidly. Housing prices are falling at a breakneck pace, especially in the eastern states, which will lead to what is known as a “negative wealth effect”. If everyone feels poorer, they will spend less.
Building approvals last month fell nearly 18%, while new home loans fell nearly 8.5% in July.
This is far from the kind of “stable while it goes” strategy that central banks have long adhered to.
Once tomorrow’s rate hike is over, RBA boss Philip Lowe will have to tread carefully.
He clings to the belief that there is still a “narrow path” to economic nirvana, that we can beat inflation and not end up in recession.
But the path becomes strewn with pitfalls.