The decision by the Reserve Bank to cut rates on Tuesday was welcome and well overdue. While all signs point to more rates cuts to come, unfortunately the RBA remains wedded to the idea that we need more people to lose their jobs in order to keep inflation low.
You might have missed it, but the inflation fight is now officially over.
After every board meeting going back to October 2022, the RBA has issued a statement that ended by saying the bank remains “resolute in its determination to return inflation to target”.
On Tuesday the bank changed the language, ending its statement by noting that “the Board is focused on its mandate to deliver price stability and full employment and will do what it considers necessary to achieve that outcome”.
It is no longer resolute about returning inflation to target, because inflation now is within the 2% to 3% target range.
Suddenly the RBA has rediscovered that it is supposed to also care about full employment. That might seem good for those looking for work, but unfortunately, the bank view of full employment is that we need more people unemployed.
For you see, the RBA continues to obsess about a “tight labour market”. It does this because it believes unemployment of about 4% will probably cause wages to rise and then prices will follow.
You would think after nearly three years of being wrong, the bank might start to question its economics. But no.
Three years of waiting for a wages-price spiral that has never come.
Back in May 2022, when the RBA first began to increase interest rates, the bank warned that “in a tight labour market, an increasing number of firms are paying higher wages to attract and retain staff”.
Unemployment at the time was 3.9% and the RBA wanted it to rise to 4.5%. Private sector wages were growing at 2.7% while inflation was more than double that at 6.1%. We were also just halfway through a record 30 months of prices growing faster than wages.
It took until the end of 2023 for wages to grow faster than inflation.
Throughout all of that time, unemployment was never above 4% and in the 15 months since December 2023, it has been above 4.1% for just one month.
What has happened in these past 15 months? Did wages rise with prices following? Nope. Wage growth fell. Inflation fell.
Does the RBA realise they got it wrong? Oh lord no!
In its statement on Tuesday the RBA board stuck to its guns, saying that while there was weak demand in the economy, “at the same time, a range of indicators suggest that labour market conditions remain tight”.
Despite this, in the May statement on monetary policy, also released on Tuesday, the RBA predicts underlying inflation and wage growth will be lower than it did in its February statement:
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This means the RBA now predicts real wages will only grow around half a percent over the next two years:
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One would think a tight labour market might result in better wages than that!
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But to be honest this is just another case of the RBA misreading the economy.
As I noted earlier this month, in April the suggested the pickup in retail sales at the end of last year was a sign of good things to come, not a blip.
Now the bank says that “recent data suggest that the pickup will be a little slower than was expected three months ago”. Oops. Don’t blame us, blame the data!
The RBA now forecasts slower household spending growth for the next 18 months than it did in February:
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Heck, the RBA now predicts the Australian economy as a whole will grow slower over the next two years that it thought was the case just three months ago:
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So, the RBA expects wage growth to be slower, household spending to be lower, the economy to be weaker than it did when it kept rates steady in April, but also that it was not wrong to keep rates steady!
Cripes, I’d have to see how bad things get for them to actually admit fault.
And here’s the kicker – the RBA is happy with everything slowing.
In its statement, the RBA noted that cutting rates “will make monetary policy somewhat less restrictive”. That means it still thinks interest rates are slowing the economy, just not by as much as before. Why on earth would you want the economy to grow slower than it is now?
The market, for its part, thinks the RBA will have to wake up soon. After the April meeting, the market predicted the cash rate might be cut to 3.35% by the end of the year; now it thinks there is very good chance of it being cut to 3.1%.
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The RBA admits inflation is under control; now
