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Why the RBA won’t copy Canada’s interest rate cut
The economic and interest rate cycle in Australia is quite different to our Canadian cousins, despite the similarity in the structure of the resources-rich, medium-sized economies.
John KehoeEconomics editorStalling economic growth in Australia, and interest rate cuts in Canada and probably Europe, have been seized on by doves to declare the Reserve Bank of Australia should soon be cutting interest rates to prevent a recession.
But the economic and interest rate cycle in Australia is quite different to our Canadian cousins, despite the similarity in the structure of the resources-rich, medium-sized economies.
Bank of Canada governor Tiff Macklem has fought inflation aggressively. Bloomberg
Canada swallowed its interest rate medicine harder and is now cutting rates sooner. The RBA is playing a slower and steadier game, hoping not to damage the labour market as much and get inflation under control.
The dovish RBA’s cash rate is lower at 4.35 per cent, versus the previously hawkish Bank of Canada trimming it from 5 per cent to 4.75 per cent.
Headline inflation is 3.6 per cent in Australia, versus 2.7 per cent in Canada. In the more closely watched central banking terms, underlying inflation is 4 per cent in Australia compared with 2.9 per cent in Canada.
The unemployment rate in Australia is a low 4.1 per cent, versus 6.1 per cent in Canada.
Avoiding Canada’s aggression
Stephen Miller, GSFM investment strategist and former economist for treasurer Paul Keating, says: “It’s too simplistic to draw parallels between Canada and where Australia is.”
“The Canadians were relatively aggressive in going after inflation and at one stage they did a 100 basis point hike in one go.
“I think the RBA is higher for longer until late this year or early next.
“I still don’t think the RBA will hike, but they’ve obviously got some thinking to do if the June quarter CPI is a surprise.”
The RBA is trying to avoid an unemployment rate with a six in front of it, like Canada’s.
This was reinforced by new RBA deputy governor Andrew Hauser in an interview with The Australian Financial Review this week.
Tepid growth like the 0.1 per cent in the March quarter is necessary to rid the economy of excess demand
The RBA board is seeking to “test” how low unemployment can sustainably be as agreed with Treasurer Jim Chalmers, justifying lower interest rates than foreign peers to tame inflation, Hauser said.
That strategy is not without risk because if inflation remains sticky and does not come down to the 2.5 per cent target, it could force the RBA to tighten interest rates harder and crunch the economy more later.
Headline inflation has stopped falling since December and has edged slightly higher in the past two months to 3.6 per cent.
Bullock comfortable
If a higher-than-expected June quarter consumer price index is printed on July 31, the RBA board will be leaning towards a rate hike in August – against every dovish bone in its body.
For now, RBA governor Michele Bullock is comfortable the 4.35 per cent cash rate is at the right level.
Bullock said on Wednesday interest rates would be cut only when the board was “convinced” inflation was falling “sustainably” into the 2-3 per cent target band.
If inflation rises or remains sticky, the RBA “won’t hesitate to move and raise interest rates again”, Bullock said.
She said the economy was “very weak”, evidenced by soft consumer spending.
Threading the needle
But Bullock drew an important distinction between everyone obsessing about the weak growth rates in demand and people paying less attention to the RBA’s focus on the high level of demand.
While GDP expanded by only 1.1 per cent through the 12 months, the level of economic output through the year was $2.4 trillion.
This is above the economy’s capacity to sustainably produce goods and services in a low-inflation way.
Tepid growth like the 0.1 per cent in the March quarter is necessary to rid the economy of excess demand and push it back towards the supply capacity to balance the economy.
The Canadians have done it more aggressively, perhaps overly so, and Australia is seeking to thread a needle like almost no central bank ever has.
It will be an historic masterstroke if Bullock and the RBA can actually deliver the soft landing.
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