Why RBA keeps erring on interest rate

Editorial

The Reserve Bank of Australia governor, Philip Lowe, recently came up with a list of excuses and admissions that the RBA erred on the timing of when it would start lifting its interest rate and described it as “embarrassing” from a forecasting perspective that it had predicted no rate rises until 2024.

Not just the rate, the RBA kept money printer on until February 2022 intentionally pumping up the supply of money in Australia (RBA governor Philip Lowe’s outdated view of good inflation and obsession with it even before the pandemic is not a well-kept secret).

Admissions, excuses, blames.

Well, it appears no lesson has been learned.

Unexpectedly, early this month the RBA broke with the peers around the world by slowing the pace of rate hikes – lifting the cash rate by 0.25 percentage point, half of what markets had expected in terms of the consistent serious efforts to curb red-hot inflation and inflation expectations.

In a statement, Lowe still said inflation in Australia remained “too high” and predicted inflation to reach 7.75 percent this year (didn’t say how), before dropping to just over four percent in 2023 and about 3 percent in 2024.

The dovish attitude and inadequate action has sent the Australian dollar (AUD) plunging to new record lows and to settle at the $0.62 level.

Meanwhile, the Fed raised its benchmark interest rate by 0.75 percentage points to 3%-3.25% and signaled plans to lift by another 1.25 percentage points before the year-end to 4.25-4.5 percent. Higher rate pushes domestic currency up.  Higher USD means lower AUD.

A lower exchange rate makes imported items like fuel, clothes, furniture, electronics more expensive, leading retailers to raise prices in Australia. It soon lifts up prices of domestically produced items too because of components, fertilisers, fuel, machinery, spare parts, maintenance, transport etc. becoming more expensive even if they remain at the same price at the international market. This means higher inflation in Australia.

Prices also rise because people expect them to. This is called inflation expectations. Plunging domestic currency is one of the factors contributing to these expectations. Again, this means higher inflation in Australia.

Higher inflation means more rate hikes. A late response means more rate hikes. And sometimes, unnecessary ones. Unfortunately, the RBA is falling behind again, bowing to the political pressure not to let house prices drop.

Besides inflation, the RBA’s dovish outlook will likely trigger rapid capital flight, the outflow of capital from Australia due to the lower interest rate than the US, AUD instability and depreciation, higher risks and lower return on investment.

If parking their money in the US means lower risk, protection against currency depreciation, higher interest earning, why would financials institutions – whether multinational or Australian -, including large banks keep, lend or invest their money in Australia?