The International Monetary Fund (IMF) have called on the Reserve Bank of Australia (RBA) to raise interest rates further.
The IMF is concerned with the persistent rate of inflation. Whilst they are confident in assuming that inflation has peaked, the rate of decline is too slow and core inflation remains firm. Despite the RBAs best efforts to date, the IMF have stated that more needs to be done to bring inflation back within target. The IMF is of the view that with continued coordination between monetary and fiscal policy responses there is scope to bring inflation back within the 2 – 3 per cent target range by 2025.
The IMF have recognised that Australia’s economy is proving resilient. Gross domestic product (GDP) growth is positive at 0.4 per cent, unemployment remains low at 3.6 per cent, and housing prices have recently picked back up after a correction in 2022. These growth metrics are inflationary, meaning that both monetary and fiscal policy have a part to play. From a fiscal policy standpoint, the IMF have called upon the government to introduce public investment projects at a “more measured and coordinated pace” in support of the RBAs disinflationary work done thus far.
The IMF are predominantly concerned with a shift in normalised inflation expectations. Any adjustments to the rate at which inflation slows, could offset the rate rises introduced to date. This could cause further pressure to introduce additional measures beyond what may reasonably be required if the issue is not addressed quickly. If inflationary pressure remains higher for longer, the inflation target expectations may shift upwards. This could cause a cascading affect whereby interest rates would have to be even higher, enforcing additional burden on mortgage holders. Simplistically, this then places permanent upward pressure on prices, wages expectations and businesses bottom line.
The economy is currently facing a myriad of external risks, with the following factors all facing uncertainty and volatility:
This makes policy setting a difficult task.
The 400 basis point interest rate tightening to date has played a role in reducing domestic demand and we have seen the supply chain pressures alleviated, which has reduced goods inflation. Services inflation on the other hand, remains high and widespread due to strong levels of demand and elevated input cost pressures.
In suggesting additional monetary policy tightening, the IMF believe that banks are well positioned to manage additional risk within their loan portfolios over the near to medium term. Implying that the RBA should consider lifting rates sooner rather than later. They believe that with robust capital levels and introducing additional assessment measures for borrowers, lenders can mitigate the increase in risk associated with higher interest rate costs imposed on borrowers.
The challenge the RBA faces when bringing inflation back within target, is ensuring they do so within an appropriate time frame and at the right rate. Pushing rates too high and too fast, could negatively impact the economy and put undue pressure on borrowers and lenders.