Over recent months several major central banks around the world have started to cut official interest rates and this week the US Federal Reserve looks set to join the group. None of the central banks cutting official rates have brought inflation down to their inflation targets yet, but some are closing in and slowing economic growth has become more of a concern to them than going the extra mile to grind inflation down to target. There are exceptions to the central banks’ rate cutting. The Bank of Japan is starting to lift official interest rates as economic growth and inflation show the first signs of sustained life in more than 30 years. In Australia, the RBA is a long way at the back of the queue of central banks that have started to cut official interest rates or are likely to cut rates over coming months.
Economic growth has been slowing in Australia, one reason why the RBA could possibly be less of a laggard cutting the cash rate. But there are several other reasons why the RBA is going to stay at the back of the queue. Among those reasons, the RBA did not hike the cash rate as much as many of its peers relative to the inflation threat it had to deal with. Australian inflation, while declining is holding up higher and stickier than overseas. Australian productivity is weak and low by international comparison while the labour market is still relatively tight by international comparison. Also, the problem of too strong growth in government spending adding to inflation pressure while monetary policy is working to try and offset and contain inflation is at least as big a problem in Australia as it is overseas.
Taking the RBA’s current 4.35% cash rate first. That sits currently alongside the latest Q2 CPI annual inflation rate of 3.8% y-o-y, or the latest monthly CPI annual rate of 3.50%. Australia’s real cash is 0.85% based on the latest monthly CPI reading. By comparison, some central banks that have started to cut rates still have real interest rates close to that in Australia, or higher.
In Europe, the European Central Bank has cut the interest rate on its deposit facility twice by 25bps and is now at 3.50% but set against EU CPI inflation of 2.2% y-o-y in August, the real interest rate is 1.30%. The Bank of England has cut its base rate once so far by 25bps to 5.00% but against July CPI inflation of 2.2%, an effective real interest rate of 2.80%.
The Bank of Canada has cut its cash rate three times in a row, 25bps each time and taking the cash down to 4.25%, but that sits against a 4-year low annual inflation rate of 2.5% y-o-y in July. Canada’s real interest rate is 1.75%. Nearer to home, the Reserve Bank of New Zealand started cutting its cash rate in August by 25bps to 5.25%, but against annual inflation that fell to 3.3% y-o-y in Q2. The effective real interest rate in New Zealand, even after the initial rate cut is 1.95%.
The US Federal Reserve is expected to start cutting its Funds rate, currently 5.50%, this week. If the Fed cuts by 25bps, as widely expected, the Funds rate at 5.25% will compare with the latest August US CPI of 2.5% y-o-y, an effective real Funds rate of 2.75%.
What is noticeable is that the central banks that have started cutting their cash rates, or will soon start cutting, are doing so against CPI inflation rates ranging between 2.2% y-o-y for Europe to 3.3% for New Zealand. Australia’s inflation rate is a high outlier at 3.5% y-o-y. But it is also Australia’s comparatively low nominal cash rate in combination with Australia’s relatively high inflation rate that means that Australia’s real official interest rate is low by international comparison, only 0.85%, against a range of 1.30% for the European Central Bank to around 2.80% for the Bank of England and the US Federal Reserve.
Apart from a real cash rate that is already very low by international comparison militating against the RBA cutting the nominal 4.35% cash rate any time soon, the RBA also has more cause than most of its peers to worry that progress reducing inflation is likely to prove to be a long and relatively slow affair.
Australia’s labour market is tighter than most. Employment is still growing very strongly, up more than 50,000 in both June and July. That would be the equivalent of the US adding nearly 650,000 to its non-farm payrolls each month (in August the US added 142,000 after an 89,000 gain in July). Australia’s unemployment rate at 4.2% in July is like the US and UK, both also at 4.2%, but is noticeably lower than the European Union, 6.4%; Canada, 6.4% and New Zealand, 4.6%.
Australia’s strong employment growth and low unemployment rate is also running in tandem with poor productivity. Australia’s GDP per hour worked was down in Q2 by 0.8% q-o-q and was up only 0.5% y-o-y. By comparison, US output per hour worked was up 0.6% q-o-q in Q2 and up 2.7% y-o-y. Part of the reason for much better productivity growth in the US than in Australia is stronger business investment spending in the US as well as a much higher proportion of growth in jobs in the US in the private as opposed to the public sector. Australia’s very strong employment growth over the past year has been driven mostly by public sector employment, notably jobs related to the National Disability Insurance Scheme.
However, the relative tightness of Australia’s labour market combined with poor productivity means that Australia’s annual wage growth at 4.1% y-o-y is sitting too high to allow inflation to come down as far and as fast as is occurring overseas.
Throw in strong growth in real government spending in Australia helping to keep demand growth running ahead of output growth even in a slow growing economy and the RBA is still a long way from being able to join the ranks of the rate cutting central banks overseas. The RBA is at the back of the queue to start cutting rates and will not get to the front of the queue before 2025 unless there are signs of much weaker economic growth, a much less tight labour market and much lower inflation in the meantime.