RBA should leave cash rate on hold but government can help inflation fight
A University of Wollongong finance expert is hoping the Reserve Bank of Australia board will leave the official cash rate on hold when it meets today, arguing that any move to raise interest rates won’t have a major impact on lessening inflation.
Dr Paul Mazzola (pictured above), a lecturer in banking and finance at the UOW Faculty of Business and Law, with more than 25 years’ experience in the Australian, European and Asian Pacific markets, said the RBA’s cash rate lever was a blunt instrument.
Mazzola said he hoped the RBA would keep the cash rate on hold on Tuesday, as lifting it wouldn’t affect inflation much.
He said only one third of Australians held a mortgage, while a third owned their own homes outright and another third were renters. Goods inflation had already substantially decreased, while services inflation “remained sticky” and “any expectation that a rate rise will materially impact aggregate demand soon is wishful thinking”.
Mazzola spoke to MPA ahead of the RBA’s May 7 meeting, sharing his views on the impacts of the RBA’s 13 cash rate increases, which were principally felt by the “battlers” (mortgage-holders), the danger that further rate rises could send the economy into recession and what the federal government could do further to cool inflation.
“The annualised inflation rate to 31 March 2024 has declined from 4.1% to 3.6%,” Mazzola said. “This marks the fifth consecutive quarter of lower annual inflation since the peak of 7.8 per cent in the December 2022 quarter.”
He acknowledged that this was a welcome trend but said there were two factors that were “spooking economists” – unreasonable inflationary expectations, and overseas “imported inflation”.
Mazzola said inflation was taking longer to fall and reach the 2% to 3% range than most expected, including the RBA itself. This led to a problem known as unreasonable inflationary expectations.
Unreasonable inflationary expectations
“That’s a sociological phenomenon whereby when we see inflation persisting for a long period of time we all expect prices to continue to increase into the future, so we all behave individually and as a group to protect ourselves against that inflationary expectation,” Mazzola said.
“The natural thing to do is to push for your own wages to increase – we call that a wages push. So there's a danger that will filter through the economy and by increasing production costs and then the cost of products and services will naturally continue to go up. It becomes a self-fulfilling spiral.”
Manufacturers and service providers may increase prices in expectation of a wages push, Mazzola said.
“That’s a trap – the RBA is conscious of that and they’re hoping to avoid that – that’s why they won’t commit to no more interest rate increases.”
The other concern held by economists was something Australia had no control over – overseas inflation.
Imported inflation
Mazzola said imported inflation occurred when goods or services were imported from a country that exhibited high inflation. The escalating prices of imports, whether in the form of manufacturing inputs or finished goods, eventually fed into Australia’s CPI figures.
“There’s one region where this is of concern – and that’s in the US,” he said.
“[President Joe] Biden has undertaken an infrastructure spend to stimulate the economy and there’s a huge amount of money being pumped into the economy by government and that's already had an inflationary impact in over the past couple of months.”
Given the US was one of Australia’s major trading partners, Mazzola said there was a risk that as “we continue to import goods and services from the US, higher prices and many of those will be inputs into our own manufacturing processes, will find their way into our own CPI basket”.
However, it was important not to overreact, because Europe and China were also major trading partners of Australia’s, and inflation was not a problem in those two areas. In April 2024, annual inflation in Europe rose by 2.4%, unchanged from March. China's inflation rate rose by just 0.1% in the year to March 2024.
Mazzola said it was only the US that posed an inflation problem and it was important that the RBA kept an eye on this but also took into account Australia’s other major trading partners when making any decision on interest rates.
‘Inelastic’ services inflation
When it came to goods and services inflation, Mazzola said the RBA’s tightening cycle had “hammered the price of goods, which have come down considerably”.
But tightening had not affected services inflation much – rents, financial services, insurance, education, medical and hospital care – the cost of these had gone up considerably.
The latest data shows that the principal driver behind the March quarterly 2024 inflation rate is services inflation, not goods inflation. These include rents (+2.1%), secondary education (+6.1%), tertiary education (+6.5 % and medical and hospital services (+2.3 per cent).
“My argument is, no matter how high you push interest rates, these are expenses that I would call demand inelastic – the demand for those services don’t vary as much if you change the price,” Mazzola said.
“Because we need those things – are you going to pull your kids out of school? Are you going to go without medical attention? Of course not, we’re going to spend on those things.”
Mazzola said the interest rate increases hadn’t had much impact on services and “that’s what’s keeping inflation high”.
Mortgage holders doing it tough
Mazzola said mortgage-holders were “being used to bring down aggregate demand because that's what interest rates are aimed to do”.
Renters were also affected indirectly, because property investors would react to increases in interest rates and pass that on in rents at the next lease renewal which could be a “year down the track”.
Mazzola said a lot of mortgage-holders were battlers.
“It might be considered to be unfair to implement that kind of [interest rate increase] monetary policy on the shoulders of mortgage holders.”
Mazzola said businesses, particularly small businesses, were the other segment of the economy that was bearing the brunt of monetary policy.
Most small businesses had some form of debt, and SMEs employed 42% of Australia’s private sector.
“My warning to the RBA is that by increasing interest rates, if we already have hammered goods inflation down, if we acknowledge that services inflation is sticky and will react minimally to any interest rate hike and we've already hurt our mortgage holders considerably and we don't want to hurt our small businesses because they employ over 42% of our private sector, there's no strong argument to lift interest rates now.”
Upcoming Federal Budget
Mazzola said the Federal Budget in May was a perfect opportunity for the government to assist the battle against inflation, by offering a “net contractionary budget”.
“In other words, don’t throw too much money around.”
Mazzola said most economists expected the government’s July tax cuts to be the equivalent of two interest cuts of 25 basis points (0.5%)
This meant the tax cuts were an “indirect” interest rate cut. Mazzola said the government should not “splash any more cash” because it would undo the RBA’s tightening cycle of the last 18 months.
“We are on the right track. I'm confident that if the government is responsible in its budget, that we will continue to see inflation trend downwards. Then it's just a matter of timing as to when we reach that magic target of between 2% and 3%.”
Mazzola said he didn’t want to make a prediction about when the RBA would cut interest rates, but Australia was moving in the right direction.
Threat of recession
“Let’s not panic and say just because we haven't come X percent [inflation] by now, we should now be bumping rates back up. The problem with that is dragging us into a recession.”
Mazzola said this scenario would occur if “we don’t spend, the economy comes to a halt and growth dips in three consecutive months.”
“That’s the big risk and that’s why I’m arguing to think very carefully about how we deal with inflation. If we increase it [interest rates] too much, it will affect growth and could throw us into recession.”
How the government can help
Mazzola said the federal government can do a lot to help drive down inflation.
This included considering reducing immigration, introducing further taxes on big businesses and increasing the GST on discretionary items.
Mazzola said immigration numbers have fuelled rental increases, which was the biggest component in services inflation.
“We've got historic levels of immigration at the moment … the first thing people need is accommodation and the easiest form of this is rental accommodation. That's what's been pushing a lot of our rents up.”
Mazzola said the government could target different sectors of the economy.
No further pressure should be placed on small businesses or mortgage-holders but the government could look at other segments of the economy, such as mining, “which has had super run over many years” and give consideration to mining taxes.
Increasing GST on discretionary items, and capital gains tax had also been “bandied around.”
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