(Bloomberg) — Australia’s interest rates will need to rise further to return inflation to the Reserve Bank’s 2-3% target and a recession is quite possible, according to Jonathan Kearns, a former senior official at the central bank.
(Bloomberg) — Australia’s interest rates will need to rise further to return inflation to the Reserve Bank’s 2-3% target and a recession is quite possible, according to Jonathan Kearns, a former senior official at the central bank.
Now chief economist at investment firm Challenger Ltd., Kearns until last year headed the RBA’s domestic markets division. His more than a quarter-century at the bank also included stints in financial stability and economic research.
In an interview with Bloomberg News, Kearns said a cash rate of 3.6% probably isn’t high enough for inflation that’s close to 7%, suggesting the RBA will need to hike further and keep rates elevated for longer.
Following are lightly edited excerpts from the Q&A.
Were you surprised by this month’s decision to pause?
It was a very close decision but in the end I wasn’t surprised. The Reserve Bank wants to avoid a recession, if possible, and so to give that the best chance they want to avoid over-tightening.
So can Australia avoid a recession?
I don’t think that Australia has a significantly greater chance of avoiding a recession necessarily than other economies. The governor is hoping that we can bring inflation down whilst limiting the increase in unemployment to less than 5%. I think that would be a very good outcome. I think there is still a significant chance that Australia does go into a recession.
How significant is that chance?
I’d say at least one-third, but that’s a guess. It’s not scientific.
Is the tightening so far sufficient to cool inflation?
Policy is probably not in and of itself sufficiently contractionary to bring inflation down from the high levels that it’s achieved. Some of the reduction in inflation will occur automatically because it was just a short term supply shock. So if we move those out of the system, we have seen that inflation is becoming even more broad spread. And it’s coming through in services and they’re the parts of inflation that are much more dependent on labor market costs.
But Australia’s wages haven’t picked up significantly?
We’ve seen some increase in the Wage Price Index. A lot of people have been surprised we haven’t seen more of an increase but some degree of wage setting in Australia is quite sticky. Labor costs do not need to be so sticky because what we’re seeing a lot at the moment is employers are offering bonuses to attract new staff, they’re promoting staff to more senior levels in order to retain them. And so you are getting an increase in labor costs that’s going to exceed what’s happening in the WPI. I think there is possibly some of this increase in wages cost that’s already feeding through to inflation.
So inflation and rates stay high or there’s a return to tightening?
My guess is it’s probably the latter. I think this is the interesting trade off for monetary policy — you can either increase the interest rates more initially and then you’ll probably have to hold them at that higher level for a shorter period of time. But if you increase them by less, then you’re going to need to sustain them at that higher level for an extended period of time. I think there’s a chance that the RBA is effectively going down the latter route in choosing to be less aggressive than, say, the Reserve Bank of New Zealand has been.
From what we’ve seen so far, it’s not clear that the current setting of policy is going to deliver that increase in the unemployment that’s needed to curtail inflation. It’s obviously very contingent on what happens with inflation expectations.
How high will interest rates need to rise then?
On some traditional economic benchmarks, monetary policy is still expansionary. If you think about the real interest rate, the cash rate at 3.6% and inflation at around 7% then you would say policy is still expansionary.
My expectation is that probably interest rates have to be higher.
Should the RBA take the cash rate above 7% to be contractionary?
No, because I think some of that 7% inflation is still the lagged effects from energy and some of the lagged effects of disruption from covid affecting supply chains. So there’s realistically some of that inflation that’s going to unwind pretty easily that’s not built into inflation expectations.
So I don’t think you need a policy rate that’s higher than the current inflation rate. Once you take out those temporary effects, is the more persistent part of inflation 5% or is it 5.5%? I don’t know. But just trying to think of ballparks. It wouldn’t be surprising if you need an increase in the unemployment rate of 2% or maybe even a little bit more to bring down inflation.
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