MNI INTERVIEW: RBA at Risk of Over Hiking - Ex-Board Member

The Reserve Bank of Australia risks overtightening if it hikes the cash rate above its current 4.1% in coming months, as the delayed impact of past increases begins to be felt, ex-board member Bob Gregory told MNI.

Interest rate increases take 12 to 18 months to have an effect, said Gregory, emeritus professor at the ANU’s Research School of Social Sciences, who served on the RBA board between 1985-1995. He pointed to the mortgage market as an example, with a large number of fixed-rate mortgages rolling off over the next few months.

"Much of the reaction to past interest-rate increases is still yet to come," he noted. "The exact timing of the average lag is not clear cut but it is of the order of one or two years.”

According to the Australian Banking Association, Q2 saw a spike in the roll off of fixed-term mortgages, with that figure tapering each quarter out to Q3 2024 (see chart). Mortgage pain, however, has not materialised in house prices, with the RBA recently noting real-estate strength had confounded its models (see: MNI POLICY: House Price Strength Thwarts RBA Models)

Gregory said waiting for unemployment to increase significantly before halting rate increases would be damaging.

"This is a lesson learned during the period of large interest-rate increases in the late 1980s and early 1990s that led to Australia’s worst post-war recession," he added. "Interest rate increases need to stop before unemployment increases start, a difficult judgment to make. Of course, the RBA attempts to look ahead, to account for lags, but forecasting is difficult."

Markets have priced in a small chance the RBA will hike again at its next July 4 meeting, with the rate now expected to peak at 4.5% by November.

LACK OF INDEPENDENCE

Gregory noted the RBA, along with other developed economy central banks, tends to quickly follow U.S. interest rate changes.

"So when our interest rate increases stop is likely to be heavily influenced by when the U.S. Federal Reserve increases stop and this is likely to be too late,” he said. “Past experience indicates that the RBA independence from the Fed decisions is limited and this is likely to be more so today as developed countries, which also tend to follow U.S. policy, have become more synchronised, stimulating their economies in response to Covid and now tightening monetary policy in response to the inflation. At the same time our unemployment begins to increase the Australian situation is likely to worsen in response to world unemployment increases."