9 min read

Why the RBA should hold steady

It's probably too late in the cycle to hike rates any further when what's desperately needed is tax, spending and regulatory reform.
Why the RBA should hold steady
Image by Braveheart / 20th Century Fox

When I was looking at the calendar a couple of weeks ago I had pencilled in the electoral bloodbath that looks set to take place in the UK tomorrow (sorry Rishi) as something to write about. But then Australia's May inflation figures came in and I thought it warranted an update, given the relatively large upside surprise (market consensus was for 3.8%):

"The monthly CPI indicator rose 4.0% in the 12 months to May, up from a 3.6% rise in the 12 months to April.

The annual movement for the monthly CPI indicator excluding volatile items and holiday travel was also 4.0% in May, down from 4.1% in April. This series excludes Automotive fuel, Fruit and vegetables and Holiday travel and accommodation.

Annual trimmed mean inflation was 4.4% in May, up from 4.1% in April."

The first thing to note is that this is the monthly inflation gauge; as I've documented before, it's a series that "can be a bit tricky to interpret because of how our stats bureau cobbles it together". Be careful reading too much into it.

This month's reading also contained a few so-called 'base effects', i.e., distortions from a year ago that have now dropped out. Government energy rebates are the primary culprit, as they temporarily lowered measured inflation. But because actual inflation hasn't been reduced (if anything, by raising demand, debt-financed subsidies increase inflation), there's an inevitable rebound effect 12-months later.

In May, the Energy Bill Relief Fund started to roll off the index, leading "to a 1.4% rise in Electricity prices in monthly terms" (up 6.5% from a year ago). And there's plenty more to come:

The Reserve Bank of Australia (RBA) is, of course, well aware that these distortions need to be 'looked through', and that the monthly indicators "don't contain a full sample of prices". Elaborating, Deputy Governor Andrew Hauser told an audience last week that:

"It would be a bad mistake to set policy on the basis of one number, and we don't intend to do that."

If I'm interpreting that correctly it means that barring a disastrous June quarter result, the RBA looks set to hold the cash rate steady at its next meeting in August (and probably many more).

But it's also completely valid to ask that, given the utter lack of progress in getting inflation back to its 2-3% target – the last six readings excluding volatile items and holiday travel were 4.0, 4.1, 4.1, 3.9, 4.1, 4.2 – should the RBA be raising rates instead?

The case for higher rates

There's a camp led by Christopher Joye that certainly thinks so:

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