Page 17 - Advice Matters Magazine - FWP - Dec 24

Why the cash rate is being kept on hold

The RBA is unlikely to start easing interest rates until the second quarter of 2025.

“The board needs to be confident that inflation is moving Although the RBA’s aggressive rate hikes totalling 425 basis
sustainably towards the target and we need to see more progress points since 2022 has depressed household spending and
on underlying inflation coming down.” weighed on growth, other factors have partly offset this effect.
That was the bottom line from Reserve Bank of Australia (RBA) “First, the surge in inward migration since Australia’s reopening
Governor, Michele Bullock, last week in justifying the central after COVID has driven aggregate demand higher, and although
bank’s decision to keep its policy cash rate on hold at 4.35%. the pace of migration is now slowing, it remains above historical
Furthermore, she noted that Australia’s underlying inflation is averages,” Dr Feng says.
forecast to be in the top of the RBA’s 2-3% target range by the “Second, government spending has played a substantial role in
end of 2025, and to the midpoint of the band by the end of 2026. supporting economic and employment growth, a trend that’s
“Right now we believe settings are restrictive and we need likely to continue ahead of the federal election scheduled for Q2
to keep rates restrictive for the time being,” she said. “We’re 2025.
watching the data closely and we’re not ruling anything in or “Fiscal policy has thus become expansionary at a time when the
out. We do think that there are still some risks on the upside.” RBA continues to maintain tight monetary conditions to curb
inflation.
Unlikely near-term rate cut
Vanguard Senior Economist, Grant Feng, says that despite “Moreover, weak productivity growth has constrained the
slowing economic growth, core inflation remains elevated, and economy’s supply capacity, underpinning unit labour costs that
Australia’s labour market remains tight. are inconsistent with the RBA’s inflation target.”
“The September quarter Consumer Price Index was largely in line Dr Feng says aggregate demand is consequently likely to exceed
with expectations, with trimmed-mean inflation increasing by aggregate supply, keeping the labour market historically tight and
0.8%, despite utility subsidies helping to reduce headline inflation the economy operating close to, or slightly above, full capacity.
to a modest 0.2% increase over the quarter” Dr Feng says. “In light of these dynamics, we expect the RBA to be slow in
pivoting toward policy easing,” he says.
“In our view, while some housing and goods related inflation is
showing signs of easing, this deceleration is gradual. Services “To tame inflation, a prolonged period of subdued demand will
inflation remains particularly resilient, bolstered by steady increases be necessary, weakening economic growth.
in administrative costs, which suggests that trimmed-mean inflation “Our base case is the RBA will not enter the easing cycle until the
will stay above the RBA’s target range in the near term. second quarter of 2025, with a gradual and slow pace to follow.
Figure 1: While subsidies and fuel have assisted headline “A focus on the supply side, especially on labour productivity,
disinflation, services has shown no disinflation this year. would be a key help for the RBA in disinflating the economy
while also lifting Australia’s long-term growth potential.”
Dr Feng says it would be less painful to achieve disinflation with
lower disruption to demand and the labour market.

“However, Australia has shown the weakest productivity growth
among comparable developed economies since the pandemic,”
he says.
“Without significant improvements on the supply side, demand
will likely need to remain suppressed for an extended period to
bring inflation in line with the RBA’s target.”

Source:
Figure 2: Measures of labour market capacity are off peak https://www.vanguard.com.au/personal/learn/smart-investing/markets-
tightness but have not loosened much this year. and-economy/why-the-cash-rate-is-being-kept-on-hold

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