Australia’s leading bank economists are deeply divided over the Reserve Bank’s likely interest rate trajectory and the Australian economy.
The cash rate target was just 0.1% at the beginning of May.
Westpac chief economist Bill Evans was not only predicting the cash rate to hit 3.35%, he also argued that it was a must if the Reserve Bank was serious about combating inflation.
In response to RBA’s Statement on Monetary Policy, released on Friday, Evans said, “The key reason why we insist that a sharper slowdown in demand is required in 2023 is that a much stronger set of demand conditions … runs the risk of resilient high inflationary expectations,” ABC reported.
The central bank’s predictions of a 3% cash rate underpin its latest economic forecasts, which did not see inflation declining even to the top of its 2–3% target range until the end of 2024.
Evans said those forecasts showed that RBA should lift rates more aggressively, even if that means slower economic growth, with Westpac’s modelling forecasting a mere 1% annual economic growth next year if rates hit 3.35%.
“Such an approach would give the bank the best chance of managing this difficult task of returning inflationary expectations to more normal levels and deflating the current ‘inflationary psychology’ which is now at risk of taking hold,” he told ABC.
Economists from CBA and NAB, on the other hand, don’t think the cash rate will go above 3% in the near future.
“I don't think it's likely to happen because I think the Reserve Bank, once they get the cash rate to around their estimate of neutral [somewhere near 2.5%], will want to pause and actually see how the economy's responding to the rate hikes that they've delivered,” Gareth Aird, CBA’s head of Australian economics, told RN Breakfast. “They are putting through a lot of tightening in a very short amount of time and, if they continue to hike at the rate that they're doing and just keep going all the way to 3% and even above that level, they're not going to be able to actually assess the impact that those hikes are having on the economy in that in that amount of time. Now, it's possible that they end up taking the cash rate to those levels, but I think if they do that, they'll end up reversing gear in the not-too-distant future because … we have a highly indebted household sector in Australia and rate rises of that magnitude will just put too many households under stress, and I think that will ultimately take the economy backwards.”
RBA claimed that “it is not on a pre-set path,” with Governor Philip Lowe saying after last week’s latest half-a-percentage-point rate rise that “the size and timing of future interest rate increases will be guided by the incoming data and the board's assessment of the outlook for inflation and the labour market.”
Aird believes the economic data will soon give the central bank reasons to stop hiking rates, ABC reported.
“I think we’re going to see in the not-too-distant future that the economy is slowing pretty materially, given how quickly they've taken the cash up right now,” he said.
Aird’s view is based largely on CBA’s own in-house economic data, drawn from the bank’s millions of customers.
“I think the RBA has tended to focus on aggregates whereas, internally, we look at disaggregated data,” he said. “What it indicates to us is that there's a lot of households that will feel the impact of the rate hikes immediately. As a result of these rate hikes, they'll have to adjust the way they're spending money. That then has an impact on household consumption.”
Shane Oliver, AMP Capital’s chief economist, may not have access to CBA’s wealth of internal data, but he has observed other early indicators that the economy is losing steam, ABC reported.
“There is tentative evidence that this is starting to show up in slowing consumer spending with credit and debit card transactions looking like they are slowing, hotel and restaurant bookings looking like they are rolling over, and July retail sales implying now falling retail sales in real terms,” Oliver said in a recent note.
Like Aird, Oliver is also forecasting a 2.6% peak cash rate – and for similar reasons.
“A rise in the cash rate to 3% or more would push total mortgage repayments [i.e. interest and principal] to record highs relative to household income,” he said, noting that the situation would hit recent homebuyers harder. “Averages can be deceiving — a bit like having one arm in the freezer and one in the oven and saying on average you are okay. While RBA analysis shows that just over one-third of households with a variable rate mortgage will see no increase in their payments with a 3% rise in interest rates, more than a third of all households with a mortgage – whether variable or fixed — will see a greater than 40% increase (and much more so for those on fixed rates). Roughly speaking, this is about 1.3 million households.”
These households are facing a triple whammy — rising rates, falling real wages, and a decline in the value of their homes, Oliver warned.
“[Rising mortgage repayments], at a time of falling real wages, will have a huge impact on spending in the economy and risk a significant rise in forced property sales,” he said. “Coming at a time when home prices are already falling rapidly due to the impact of rising rates on home buyer demand, it will only add to home price falls, which will weigh further on consumer spending.”
RBA does not have any mandate to target property prices, but Aird and Oliver both agreed that it would be a major consideration, given the impact that a perceived fall in wealth is likely to have on consumer spending, ABC reported.
CBA’s forecast was for a major property market correction that risks turning into a housing crash — where prices drop at least 20% from their peak.
“We're looking for around about 15% peak to trough — that's conditional on the cash rate getting to 2.6%," Aird said. “If the RBA was to take the cash rate higher than that then we'd be forecasting a bigger fall in home prices.”
The CBA economist does not think that is likely though.
“We're actually thinking that rates will go down in the second half of next year, such is the weight that these higher rates will actually have on the household sector,” Aird said.
Oliver also remains positive that the cash rate will not need to increase much further to put inflation under control, as some of the biggest price rises stop of their own accord.
“Core inflation in the US is showing signs of having peaked and Australia appears to be following the US by about six months, pointing to a peak in inflation here later this year,” he said. “A return to more normal weather after the floods should also help lower local food prices.”
In this battle of forecasts, the difference between a 2.6% cash rate and a 3.35% cash rate is around $284 a month for homeowner with a 30-year $600,000 mortgage, ABC reported.
