Despite headline inflation cooling since late 2022, central banks including the Reserve Bank of Australia have kept hiking interest rates well into the final months of 2023 due to concerns about sticky core inflation.
The last mile of monetary policy tightening is very likely to be the most difficult, since risks are increasingly two-sided – hike interest rates too much and the economy could slump, don’t hike enough and elevated inflation could last longer than expected.
Over the last fortnight, major central banks chose to hold interest rates at current levels rather than hiking further. In the United States, the Federal Reserve held rates steady despite the economy growing at a rapid pace. Broadly, a strong economy and cooling inflation have kept hopes of a soft landing intact for the US.
The European Central Bank and the Bank of England also held policy rates steady as core inflation cooled but, unlike the Fed, both are constrained by weak growth and considerably weaker economic outlooks. It is possible that the Fed, ECB, and BOE will have to hike interest rates further in the coming months based on international factors such as the unrest in the Middle East and domestic factors linked to tight labour markets. The current pauses are therefore best described as hawkish.
On Tuesday, the RBA broke away from the pack by hiking the cash rate to 4.35%. In fact, the RBA has not been in sync with its peers through the tightening cycle — it started hiking interest rates later and paused earlier than each of the Fed, ECB, and BOE. But the Australian context has also been different for several reasons:
These idiosyncrasies mean the RBA’s decision to increase the cash rate further will disproportionately weigh on renters and households with outstanding mortgages, while the supply-side problems driving inflation are unlikely to be solved anytime soon.
Australia will start 2024 with a rising share of households entering financial stress, and economic growth is likely to remain muted through the first half of next year as a result. Deloitte Access Economics’ view is that a weak economy will require lower interest rates in the second half of 2024. A ‘higher for longer’ approach could unnecessarily deepen the economic slump in Australia.
Chart: Annual inflation, Australia and international comparisons
Source: ABS, BLS via FRED, ONS, Eurostat, Statistics Canada
This newsletter was distributed on 9th November 2023. For any questions/comments on this week's newsletter, please contact our authors:
This blog was co-authored by Lester Gunnion, Manager at Deloitte Access Economics.
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