The only reason the RBA will cut rates next year starts with R

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But core inflation is expected to remain stubbornly and uncomfortably above target.

A plausible scenario is for local inflation to move from the forecast near 8% to, say, around 4%, over the next year.

But inflation-fighting central banks like the Reserve Bank of Australia will need to “wring out” the remaining price pressures over the next two years to limit inflation expectations from businesses passing on costs and workers clamoring. salaries.

The only reason to lower rates next year

The only way the US Federal Reserve and RBA will cut interest rates next year is if they inadvertently impose a severe recession – a scenario they are trying to avoid by slipping through the proverbial “narrow window”. “.

Even if there were a mild recession, there is no guarantee that the Fed and RBA would cut rates unless inflation cools quickly and they are confident that core inflation will return to their targets. 2% and 2% to 3% respectively. hundred.

Money markets predict a maximum RBA cash rate of over 4%.

While that sounds like overly hawkish, the money market has been more accurate than most forecasters during the pandemic, so it shouldn’t be dismissed lightly.

It is foreseeable that the RBA cash rate will be above 3% until next year.

Strong July retail spending data shows that the string of rate hikes since May has yet to dampen buyer enthusiasm. Gerry Harvey of Harvey Norman and Rob Scott of Wesfarmers continue to see healthy consumer demand.

Another 0.5 percentage point hike in the key rate to 2.35% next Tuesday seems assured.

With high inflation and full employment now generating a notable rise in wages in the second half of the year, the RBA will need to move the cash rate above the so-called neutral rate into restrictive territory to cool the surge in consumer spending and vent the heat. . of the tight labor market.

The dilemma is that the RBA, like everyone else, has no idea what the neutral rate is – the rate at which policy is neither stimulative nor restrictive.

Alan Greenspan, then chairman of the US Fed, said in the early 2000s: “It is very difficult to know where the so-called neutral rate is.

“But we’ll probably know when we get there because we’ll see some degree of balance, which we haven’t seen before, which would suggest we’re somewhere very close to where it is.”

Nominal neutral rate of about 3.5 pc

The RBA won’t really know what the ballpark neutral rate is until after the event.

The full effects of monetary policy take 12 to 18 months to appear. It is flying blind with aggressive (but necessary) rate hikes.

Governor Philip Lowe has spoken of a neutral rate of “at least” 2.5%, but doesn’t want people to give too much credit to it because the RBA doesn’t have much confidence.

The “at least” 2.5% rate is just a default consequence of being in the middle of the inflation target and Lowe’s hope that the real rate (adjusted for inflation) is zero or more.

A 2017 RBA paper suggested real the neutral rate was about 1 percent, which implied a nominal neutral rate of about 3.5 percent.

This assumes annual labor productivity growth of 1%, something Australia has struggled to achieve for much of the past decade.

This week’s Jobs and Skills Summit should set out a serious agenda to raise productivity to raise real wages.

The absence of the chairman of the Productivity Commission, Michael Brennan, from the list of 142 invited participants is curious, given the Albanian government’s repeated speeches on productivity.

The summit appears destined to deliver some quick and easy fixes for increased skilled immigration, more investment in skills and training, and a future path for workplace relations reforms.

A more flexible global Better Off test in corporate bargaining would see more productivity-enhancing TSA deals finalized, instead of industry arbitrator and third-party unions blocking deals that sometimes have 80-to-4 support. 90% of staff.

But these aforementioned areas will not be enough to revive the low productivity growth of 50 years.

After the jobs summit, serious consideration should be given to reforming a tax system that penalizes workers and allows the asset-rich to profit from competition, boost competition with incumbents and gain efficiencies through data and technology in government-dominated sectors. care for the elderly, health, care for the disabled and education.

Higher productivity is the only way for workers to feel the benefits of real wage increases.

If all we get is a rise in nominal wages that adds to inflationary pressures, the RBA will have no choice but to tighten monetary policy further.

Australia does not – at this stage – have a wage-price spiral like the United States. Persistent wage pressure could emerge.

Additionally, Australian households have much stronger balance sheets than their US and European counterparts, where household savings have returned to pre-COVID levels.

The resilience of local households will be tested by rising interest rates causing property prices to fall.

But the RBA will want to be convinced that inflation is back on target before giving up the fight against inflation prematurely.

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