Why it’s ‘premature’ to be thinking about rate cuts

Saying that the board had recently quashed hopes for any rate cuts in the near term, Bullock reiterated her comments from this month’s cash rate decision, highlighting that inflation was still too high to warrant a drop in the 4.35 per cent cash rate.

Though declining from its peak of 7.8 per cent in late 2022, inflation remains stubbornly high. For example, by the end of 2023, inflation had dropped to 4.1 per cent, primarily due to a decrease in goods prices as supply chain issues eased. However, progress has been slow since then, with inflation inching down to 3.8 per cent by June 2024.

Bullock told the hearing that underlying inflation is still “too high” at 3.9 per cent (though the RBA expects this will fall to around 3.5 per cent by the end of this year), largely as a result of high services inflation (which is sitting around 5 per cent) and high rents and insurance costs.

The central bank governor said: “At its meeting on 5 and 6 August, the board decided to leave the cash rate unchanged at 4.35 per cent. It recognised that while inflation had fallen substantially since its peak, it is still some way above the midpoint of the 2–3 per cent target range.”

The RBA’s central forecasts expect inflation to return to the target range “late in 2025” and to only approach the midpoint of the target band in 2026.

“This is a slightly slower return to target than we were forecasting in May,” Bullock told the economics committee, saying that the gap between aggregate demand and supply in the economy is larger than previously thought.

“Even though growth in the economy has been weak, the level of demand for goods and services is still higher than the ability of the economy to produce those goods and services.

“Inflation is proving persistent. But the board remains vigilant to upside risks to inflation and noted that policy will need to remain sufficiently restrictive until it is confident that inflation is moving sustainably towards the target range.”

RBA could have hiked more and faster, but held off

As the central bank tries to walk the “narrow path” between reducing inflation to target levels “in a reasonable timeframe while preserving as many of the gains in the labour market”, Bullock said that while inflation was dropping, it was doing so slowly.

Indeed, despite some economists still pricing in a rate cut by the end of the year, Bullock was adamant that the board’s message is “it is premature to be thinking about rate cuts”.

“Inflation is still too high and, in underlying terms, is not expected to be back in the top of the band until the end of next year,” she said.

“Circumstances may change, of course, and the outlook is uncertain. But based on what the board knows at present, it does not expect that it will be in a position to cut rates in the near term.”

In fact, Bullock pointed out that many other central banks overseas had increased rates by more than the RBA, but said that the Australian central bank had been “trying to balance bringing inflation back down over a reasonable timeframe, without inflicting unnecessary damage on the labour market”.

She told the committee: “One way to get back into target would have been to increase interest rates even further and even more sharply and we probably would have got inflation a bit more quickly but we might have had some collateral damage on the labour market.

“We’re willing to take [our] time in order to ensure we preserve the employment conditions,” Bullock said, emphasising that while unemployment has been “drifting up” (currently at its highest level since November 2021) it was still low by historical standards and jobs were still being created.

“And the board’s judgement to date has been that policy is currently sufficiently restrictive to do that.”

While Bullock said she understood that “this is not what many households want to hear”, particularly as those with mortgages are “feeling the squeeze on their cash flows from the increase in interest rates over the past couple of years” and “businesses too are facing higher borrowing costs”, the RBA governor said that “the alternative of higher inflation for longer is much worse”.

‘Many people have forgotten how bad high inflation is’: Bullock

According to the RBA governor, while inflation has not been this high for a few decades, “many people have forgotten how bad it is”.

“Some younger people will not have experienced high inflation at all,” she said.

“There is a reason why there is so much talk about the cost of living – high inflation hurts everyone. It reduces what people can buy with their wages, erodes the value of savings, and it disproportionately hurts those on low or fixed incomes.

“This is why it is imperative that we do what we need to [to] ensure inflation returns to levels at which it is in the background again.

“[W]e know the future is uncertain and that we therefore need to be humble in our forecasts, be willing to learn from our errors, and use a diverse range of models and qualitative intelligence, as well as internal and external challenge. And we need to respond as the economy evolves…

“The board is of the view that it currently has the balance right between reducing inflation in a reasonable timeframe and maintaining the gains in the labour market.

“Ultimately, our full employment goal is not served by letting inflation stay above target indefinitely. So, the board remains focused on the potential upside risks to inflation.”

[Related: Majors observe hawkish shift in RBA’s stance]