The RBA could be slower to follow the rest of the world in cutting interest rates due to the nature of Australia’s previous tightening cycle.
The global interest rate cycle has turned, with leading central banks shifting from monetary policy tightening to easing. The Bank of Canada and the European Central Bank both cut rates back in June this year, followed by the Bank of England, which delivered its first rate cut in more than four years on 1 August, and then by the Reserve Bank of New Zealand (RBNZ) with its first post-pandemic rate cut on 14 August.
However, the decisive moment came on 23 August, when US Federal Reserve chair Jerome Powell delivered the keynote speech at the central bank’s Jackson Hole symposium in Wyoming. “The time has come for policy to adjust,” Powell told his audience, adding “the direction of travel is clear [although] the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks”.
The Fed is widely expected to deliver its first rate cut at the 17–18 September Federal Open Market Committee meeting.
Powell’s speech heralds the end of one of the most unusual monetary policy tightening cycles of the past half-century. According to one recent quantitative review, the 2020–24 cycle was unprecedented on several counts. It featured the fastest pivot from active easing to policy tightening since the 1970s. This cycle involved the most globally synchronised period of rate increases across advanced economies in more than 50 years. The tightening itself was the most aggressive since the 1990s. And interest rates were also held at their peaks for much longer than they had been in most previous cycles.
Strikingly, this delivered disinflation at the cost of remarkably little collateral damage. At least, so far. While there have been occasional tremors across the global economy — the March 2023 banking turmoil in the US and August’s financial market turbulence — earlier fears of international financial crises or a deep global recession have failed to materialise. Indeed, the cost of lower inflation in terms of higher unemployment proved much more modest than most economists had expected when interest rates first started to rise across the globe in late 2021 and early 2022.
Why is it so?
Powell used some of his Jackson Hole speech to discuss why things played out this way. The emerging consensus among economists is that much of the post-pandemic surge in inflation was due to an “extraordinary collision” between overheated and temporarily distorted demand on the one hand, and constrained supply on the other.
The former reflected the extremely stimulative fiscal and monetary policies deployed in response to COVID-19, the unleashing of pent-up demand once lockdowns were eased, the consequences of changes in work and leisure practices over this time, and the expenditure of excess savings accumulated during lockdowns.
The latter was due to the persistent adverse impact of the pandemic on global supply chains, ongoing disruption to production in China in particular, and the consequences of Russia’s invasion of Ukraine for global energy and food prices. As a result, the initial inflationary impetus came not from the labour market, but from price increases in the goods market. Tighter labour markets only started to play a supporting role later in the process.
The relatively painless nature of the later disinflation was therefore partly a product of the unwinding of earlier shocks. It was also a consequence of the way labour markets adjusted via a decline in previously elevated vacancy- unemployment rates that mostly took the form of a fall in vacancies rather than a rise in unemployment. Meanwhile, well-anchored inflation expectations allowed inflation to fall without the precondition of significant additional spare capacity in the economy. In Powell’s words, “the pandemic economy...proved to be unlike any other”. For once, it really was different this time.
Closer to home
What are the implications of all this for the Reserve Bank of Australia (RBA)? Spurred on by the global policy shift, domestic financial markets are predicting Australia’s central bank will soon join the rate-cutting cycle. But the RBA has been sending a different message. In her press conference following August’s policy meeting, RBA governor Michele Bullock stressed that the board remained “concerned about the degree of excess demand in the economy” and cautioned that “a near-term reduction in the cash rate doesn’t align with the board’s current thinking”. In her view, market expectations for interest rate cuts had got “a little bit ahead of themselves”.
One reason the RBA might prove slower to follow the rest of the world in cutting rates is the nature of the previous tightening cycle here in Australia. Two features stand out.
Firstly, the RBA was slower to tighten than many of its peers. The RBNZ and the Bank of England started hiking in late 2021, for example, followed by the US Fed and the Bank of Canada in March 2022. Yet the first increase in the RBA’s cash rate target only arrived in May 2022, in part because inflation accelerated later here than overseas. Much as we lagged other advanced economies on the way up, so might we lag them on the way back down.
Secondly, the RBA hiked by less than many of its peers, with Australia’s policy rate peaking at a lower level. Why? Martin Place argued that not only were inflationary pressures here less, but also that the prevalence of flexible rate mortgages in Australia meant a given rate hike had more traction. To the extent that changes in interest rates have symmetrical effects, the same story could apply to rate cuts.
There is also another factor at work. Burned by its forecasting failures at the start of the post- pandemic inflation surge, Australia’s central bank is not confident about the near-term outlook for inflation. This caution saw RBA-watchers highlighting the quite considerable number of references to “uncertainty” in the minutes for the August 2024 board meeting, for example. So, while the global rate cycle has turned, the implications for the near-term path of Australia’s policy rate remain, well, somewhat uncertain.
AICD chief economist Mark Thirlwell GAICD has focused on the international political economy at the Bank of England, JPMorgan, Austrade and Export Finance Australia.
This article first appeared under the headline 'A lack of certainty’ in the October 2024 issue of Company Director magazine.
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