How the RBA cheated Australian households

Given Australia’s strong economic growth supported by high export prices, low unemployment and evidence that wages are rising from a bland base, there is an attractive case for starting to normalize cash rates towards a non-contractive or expansionary cost of capital.

The problem is that although the RBA has repeatedly alleged that this “neutral” rate is at least 2.5 percent (or a chunky 175 basis points above its pre-pandemic cash rate), the reality is that the RBA has no idea where “neutral” really is. You only know once you are there.

Worthless prophecy

The RBA’s 2.5 percent estimate is another estimate not worth the paper it’s written for – such as its view in early March 2020 that the pandemic was no big deal and then its subsequent overly pessimistic forecast for a deep recession.

Given the unmatched sensitivity of the Australian economy – dominated more than others by more variable rate debt, rather than fixed interest rates – to interest rate changes, prudent policymakers will gradually raise cash rates within the standard, 25 basis. -point increase every month and “show now” real time data stream to assess impact. That might get you to 2.5 percent, or you might have to stop far from that mark.

Ironically, this is the logic the RBA used to rationalize its first 25 basis point gain in May, as opposed to the 15 or 40 basis point gain economists and markets had hoped for. The RBA explained that it rejected 15 basis points because this would be “inconsistent with the historical practice of changing the cash rate in increments of at least 25 basis points”. And it dropped 40 basis points as a 25 basis point move would “help signal that the board is now returning to normal operating procedures after the extraordinary period of the pandemic”.

So consumers have to conclude that the RBA is signaling that they are facing an inflation crisis that warrants radically higher rates given that it has exhausted their budgets with two consecutive 50 basis point increases, and very unusual, and an extraordinary 125 basis point total. points increased in just two months (or more than the three meetings that took place from May 4 to July 6?

The crisis seems so bad that the RBA is increasingly conditioning households through the media to brace for an unprecedented third 50 basis point hike in August, meaning interest rates will rise by a staggering 175 basis points in just three months (or so four). meeting times).

The last time this happened was in 1994 when the RBA’s interest rate was about five times higher than its starting point this year (therefore, the proportional change in interest payments was much smaller). And in 1994, the ratio of debt to household income was only 44 percent of its current level. Simply put, Australians were much less sensitive to changes in interest rates 28 years ago.

CBA economist Gareth Aird said that “despite the 3.9 percent unemployment rate, the actual wage yield is a record low for a tightening cycle”. “Yet households are charging the most aggressive rate hikes for decades combined with very negative, or inflation-adjusted, real wage growth.”

Economy Crysis

The economy could collapse as a consequence. There are already worrying signs in the high-frequency data. Consumer confidence has fallen towards record lows observed during the GFC and in March 2020. House prices in Sydney and Melbourne fell at double-digit annual rates, likely to increase if the RBA delivers a third 50 basis point gain.

The biggest concern is arguably the shock of household expectations conveyed by the RBA. Martin Place spent all of 2020 and 2021 telling every Australian that everything but rates are guaranteed to stay low for a long time.

Throughout 2020 and much of 2021, governor Phil Lowe appealed to consumers, businesses and governments to take advantage of the ultra-cheap money vaults knowing the RBA would protect them from higher interest rate risks.

Australian households responded by increasing their debt to disposable income ratio to a never-before-seen 187 per cent. Housing values ​​jumped 37 percent – ​​or a record 656 percent of disposable income – reinforcing its role as the largest source of household wealth.

The RBA’s long-term low-rate guarantee is explicitly underwritten by a bold interest rate peg at which it keeps the 2024 Commonwealth bond yield at 0.1 percent the same as the overnight cash rate. This is to show the public that interest rates will remain at 0.1 percent until at least 2024.

As recently as late last year, the RBA dismissed calls for a rate hike in 2022 as unreasonable. “I want to reiterate a point I made a few weeks ago – namely, the latest data and forecasts do not guarantee a cash rate increase in 2022,” Lowe comforted consumers on November 16.

In just six months the central bank has gone from uber-dovish to ultra-hawkish as a result of supply-side inflation while interest rates are not going to help much. It began in October 2021 when the RBA abruptly abandoned the intra-month 2024 peg, a move that bond manager Charlie Jamieson described as the most humiliating event the central bank has faced since George Soros pummeled the British currency out of the European exchange rate mechanism. in the early 1990s.

One can sense how the RBA became confused by the odd error in the statement released after this week’s board meeting. In a landmark final paragraph, the RBA said: “Today’s rate hike is a further step in the extraordinary withdrawal of monetary support being put in place to help insure the Australian economy against the worst possible impact of the pandemic.”

But Tuesday’s rate hike, in fact, did not represent a remarkable withdrawal of monetary support. In October 2019, nearly six months before the pandemic ravaged markets, the RBA cut interest rates from 1.0 percent to 0.75 percent. Last month, the RBA raised interest rates from 0.35 percent to 0.85 percent.

Thus, the RBA’s interest rate before the board meeting was actually higher than it was on March 3, 2020, one day before the RBA decided to reduce the 0.75 percent rate by just 25 basis points to 0.5 percent. The RBA was immediately forced to rectify that mistake with an unprecedented intra-month meeting 16 days later on March 20 when it cut interest rates by 25 basis points and announced a series of additional monetary policy support measures, called this column. since late February.

Aussie consumers are being hit by the fastest rate hike in a quarter of a century crushing their disposable income; a massive reduction in real wage growth as a result of a huge increase in inflation; the specter of their biggest asset decline on record; the largest decline in pension savings since the GFC; and the prospect of higher unemployment as rising interest rates crush demand.

For years the RBA has been humiliated for keeping core inflation below its 2-3 percent target and for keeping unemployment at exorbitant levels that fail to support decent wage growth. As a result, both political parties have agreed to an independent review of why the central bank failed to fulfill its mandate.

However, at the first sign that the RBA was finally able to fulfill its statutory dual goals of full employment and price stability, Martin Place ran the risk of dumping the baby in the bathwater.

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