Surprise Hold? RBA Decision Not as Clear-Cut as Markets Expect

Low unemployment, rising consumer spending, and stubbornly high inflation in the United States may prompt Reserve Bank Governor Michele Bullock to keep the cash rate unchanged despite markets perceiving the first post-pandemic rate decrease as a near certainty.

Some senior economists, including Warwick McKibbin, who sat on the RBA board from 2001 to 2011, believe there isn't a compelling case for decreasing the official cash rate for the first time in more than four years at Tuesday's much-anticipated meeting.

Both major political parties are waiting for the RBA board's decision ahead of a federal election that will be contested mainly over cost-of-living issues, notably home affordability.

However, with the unemployment rate at only 4% and underlying inflation at 3.2 percent, McKibbin, who also worked as an RBA official from 1975 to 1991, described Tuesday's meeting as a "line ball."

"I wouldn't be cutting rates right now," he told The Australian Financial Review. "We've seen the difficulties of doing that in the United States, where they slashed interest rates prematurely and now had to retreat. This creates a lot of uncertainty and challenges for the economy.

Between September and December, the US Federal Reserve decreased interest rates by one percentage point, lowering the official policy rate from 4.25 percent to 4.5 percent. However, with core inflation staying at 3.3%, considerably above the Fed's 2% target, the Fed has been forced to reevaluate the outlook, and markets expect only one more rate decrease by the end of this year.

Treasurer Jim Chalmers stated that even if the RBA decreases interest rates, the government will continue to prepare fresh cost-of-living measures to release before the election, stressing that cost-of-living concerns were more pervasive than merely mortgage repayments.

Opposition Leader Peter Dutton said he hoped the RBA would decrease interest rates, but that alone would not alleviate voter dissatisfaction with the cost of living.

"It is the price of groceries, power, and gasoline. Albanese has raised all of them, and the worst part is that under a Labor-Greens minority government, prices will rise much further," he warned.

Bond markets predict an 88% chance that the RBA board will decrease the cash rate to 4.1% at its first meeting of the year. The RBA's decision might have an impact on the date of the upcoming federal election, which is scheduled for May 17, as well as how the major parties campaign on the economy.

Prime Minister Anthony Albanese may seek to capitalize on a rate cut by calling an election as early as this weekend, clearing the way for a late March polling day. If the RBA board keeps rates unchanged, there is a chance of a drop at its April 1 meeting.

The RBA has raised interest rates 13 times since May 2022, bringing the cash rate to a 13-year high of 4.35 percent and marking the quickest tightening cycle in a generation.

'Surprise Hold' Remains a Possibility

Economists who support a rate drop think that underlying inflation will soon reach the central bank's 2% to 3% target band. However, Deutsche Bank macro strategist Lachlan Dynan said the probability of a "surprise hold" was higher than the market expected.

"Strength in labour market indicators hasn't been isolated to a single measure: cyclical measures appear to have tightened since mid-year, like underemployment and youth unemployment," he said.

Dynan also cited a significant increase in state and federal government spending as a reason why the RBA board could maintain the cash rate unchanged. State and federal government spending is at an all-time high as a percentage of GDP.

"There appears little chance of Australia losing its peer-leading status in fiscal spending, with further sugar hits promised as the federal election approaches, no indications of a desired fiscal tightening from the opposition, and spending upgrades from some states," the economist explained.

After nearly two years of stagnation, retail spending has begun to increase. According to Suncorp senior economist Paul Brennan, the recent increase in household spending suggests that a rate cut is unlikely because firms will likely pass on cost constraints to consumers.

Campaign of Pressure

Some government MPs are concerned that a small number of market economists and media commentators have encouraged the independent RBA not to decrease interest rates for fear of being viewed as giving in to political and community pressure.

Chalmers insisted on Monday that the RBA was independent and that Labor was not attempting to compel it to decrease rates. However, junior minister Matt Thistle Thwaite said mortgage holders "deserve some rate relief," while Victorian Labor MP Sam Rae was more frank.

"I want a cut, and my community needs a cut," he told Sky News. "I agree with the treasurer and most others that the RBA is independent, and that its decisions will be based on economics rather than politics." That's vital.

"But my job is to stand up for my community, and we need a cut."

Tanya Plibersek, a cabinet member and environment minister, was more reserved. "Any of us who have got a mortgage would like a cut, that's for sure," she told me.

Westpac chief executive Anthony Miller said an interest rate decrease would help businesses by alleviating budget strains on mortgage holders, echoing Commonwealth Bank CEO Matt Comyn's prior statement that lower rates would boost corporate confidence.

Alex Joiner, chief economist at IFM Investors, said he had never seen market economists, politicians, commentators, and the media all clamoring for rate cuts when there were "quite obvious" reasons to be cautious.

"The RBA will be judged quite harshly should it be bullied into a policy mistake," warned Mr. Abbott.

McKibbin agreed that one of the reasons markets were so confident of a rate drop was because they believed the Albanese administration was putting pressure on the RBA.

"There was a coordinated attempt. Politicians and left-wing academic commentators frequently advocate for rate cuts ahead of elections. I would simply ignore those comments since they are political."

McKibbin stated that the rhetoric used by Albanese government MPs when discussing monetary policy was significantly more challenging than previously, citing Chalmers' comments in September that interest rates were "smashing the economy."

"There's a lot more commentary now than when I was on the board," he told me.

"Everybody reads the media. You read the comments. This is all part of the data collection... I never felt under true pressure; it was just frustrating because a lot of it was misinformed and based on self-interest."

The Australian National University shadow RBA board, which forecasts what the RBA should do, estimates there is a 52% chance that a rate drop would be the right move.

However, top economic modeler Chris Murphy believes the cash rate should be held steady until at least mid-2025, regardless of whether the model employed backward-looking data on inflation and unemployment or forward-looking projections.

"The outlooks for inflation and unemployment justify cuts of 25 basis points later, in mid-2025 and again in late-2026," says Mr. Murphy.