Reserve Bank of Australia governor Philip Lowe scored an under-the-radar victory this week when Treasurer Josh Frydenberg, after months of deliberation, ultimately determined thebank’s 2 to 3 per cent inflation targeting framework should remain intact.
Beyond the officially declared reason that the systemhad served Australia well for 28 years of consecutive economic growth,AFR Weekendcan reveal the government ultimately resisted tweaking the agreement for at least two other undisclosed reasons.
First, senior government members have reservations about whether recent interest rate cuts by the RBA are having as much positive impact as had been hoped.
Consumer confidence has dived despite the cash rate being slashed three times since June to 0.75 per cent.
Westpac chief Brian Hartzer, whose profit margins are being squeezed by falling interest rates, told a Canberra parliamentary committee on Friday that while lower rates boosted house prices, they were seen by some customers “as a negative symbol … and a sign something is wrong and there is a weakness in the economy”.
Ultimately, this may be a short-term sentiment blip, as the benefits of lower rates – a weaker Australian dollar helping exporters, and borrowers enjoying better cash flows or paying down debt faster – fully take hold over the next nine to 18 months.
Nevertheless and secondly, there is also some consternation in the government about the RBA possibly pursuing unconventional stimulus next year by artificially creating money and buying government bonds in a process technically known as quantitative easing.
So-called “money printing” could further undermine consumer confidence and be politically troublesome for a government insisting the economy is strong.
The recent monetary policy thinking in Canberra is a shift from before the June, July and October rate cuts, when the government was happy for debate to run to pressure the RBA to take more of the load to stimulate the economy.
The RBA’sstatement on monetary policyon Friday acknowledged its October rate cut “brings closer the point at which other policy options might come into play.”
“It also took into account the possibility that further easing could unintentionally convey an overly negative view of the economic outlook, or that the usual channels of policy transmission might be less effective at low interest rates.”
Tweaking the government-RBA monetary policy agreement, as was entertained by the Treasurer, would have made even looser monetary policy more plausible, at least at the margin, over the coming months and years.
While Frydenberg never seriously considered changing the numerical 2-3 per cent target band, Treasury hadprovided options to “harden” the target to put more onus on the RBA to hit its midpoint.
Under Lowe’s leadership, underlying inflation has undershot 2 per cent for 15 consecutive quarters. But Lowe is not alone.
In three-quarters of the world’s advanced economies, inflation is under 2 per cent, and in one-third of these economies it’s below 1 per cent, Frydenberg noted.
The digitalisation of the economy, globalisation, extra labour supply from women and older workers joining the workforce, high savings rates in Asia and indebted households have all contributed to soft inflation and low interest rates around the world.
Bank of England governorMark Carney warned on Friday, “The world risks slipping into a low-growth, low-inflation rut caused by deep structural forces, limited policy space and growing concerns over the fracturing of the global trading system.”
Frydenberg canvassed measures to hold the RBA more accountable to achieve its target, such as the British model whereby the Bank of England governor isrequired to write an explanatory letter to the chancellor of the exchequerif the bank misses its inflation target by more than 1 percentage point.
Lowe convinced Frydenberg the RBA’s dozens of public presentations provide ample opportunities to be held to account and explain the bank’s inflation-targeting credentials.
The government’s decision to renew the 2016 monetary policy agreement signed by then treasurer Scott Morrison was revealed byThe Australian Financial Reviewthis week.
It may appear a non-event, particularly because it is consistent with Morrison’s determination to project steadiness and stability. But in an unprecedented era of a record low rates and subdued inflation the decision has real-world ramifications for borrowers, investors and business.
The “no change” monetary policy agreement between the Treasurer and RBA governor means that the bank will have a bit of breathing space to lift the 1.7 per cent inflation rate into the 2-3 per cent bandover the “medium term”, rather than being under pressure to immediately revive prices.
Nevertheless, though financial markets in the past week have reduced the chances of future interest rate cuts, traders are still pricing in about a 55 per cent chance of the cash rate falling to 0.5 per cent by April 2020.
The RBA does not expect inflation to hit 2 per cent through to the end of 2021 and bond market pricing indicates thatLowe will struggle to steer inflation back into the band by 2024.
The policy tensions between Martin Place and Canberra are only likely to intensify.
The rub for the government is that with no extra formal pressure on Lowe to hit the target and the bank nearly exhausting traditional interest rate ammunition, the political, economic and financial market conversation will inevitably build on fiscal policy playing a larger role.
Economists at the Commonwealth Bank and Westpac this weekurged the government to fast-track personal income tax cutsto stimulate a sluggish economy.
Labor has been calling for a “responsible” fiscal stimulus via tax cuts, infrastructure spending or boosting the unemployment benefit.
And Lowe himself has earlier pleaded for the government to seize on record-low borrowing costs to fund more infrastructure investment and pursue structural economic reforms to lift wages, inflation and the economy.
With the government absolutely committed to delivering a budget surplus – forecast at $7.1 billion in 2019-20 – the policy tensions between Martin Place and Canberra are only likely to intensify despite the renewed monetary agreement.