Australia should keep tightening policy to cool demand, IMF says

AUSTRALIA should keep tightening monetary and fiscal policy to help cool domestic demand and keep inflation expectations in check, the International Monetary Fund (IMF) said.

“Monetary policy needs to be focused first and foremost on keeping inflation expectations well anchored, which clearly points to more tightening in the short term,” IMF staff said in their concluding statement of their Australia 2022 Article IV mission on Wednesday (Nov 16).

“However, there remains uncertainty with respect to the intensity of monetary policy transmission,” the statement said.

Australia’s high household debt and large share of mortgages on variable rates or resetting to them soon points to relatively strong transmission. On the other hand, savings built up during the pandemic point to significant buffers that “could dampen and delay” the transmission, the paper said.

“Careful communication of the assessment of the balance of risks and of policy intentions will thus continue to be key in guiding market expectations,” it added.

The Reserve Bank of Australia (RBA) has raised interest rates by 2.75 percentage points since embarking on its tightening cycle in May and has said it will hike further as it predicts consumer-price growth will peak at 8 per cent this year.

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Economists and markets expect the RBA will lift borrowing costs by another quarter-point next month, taking the cash rate to 3.1 per cent.

The new Labor government also handed down a relatively tight budget last month that sought to keep a lid on spending.

So far, Australia’s A$2.2 trillion (S$2 trillion) economy is weathering policy tightening and escalating inflation relatively well. Households spending is holding up and exports remain strong.

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But cracks are appearing, with property prices falling and consumer confidence weak. Hiring is also showing signs of stagnating, with the economy adding just 500 jobs in the past three employment reports.

In the IMF staff’s baseline scenario, Australia is expected to steer clear of recession but with “significant downside risks”. A rapid cooling in the housing market has the “potential to accelerate, which can reduce household consumption, with some impact on banks’ balance sheets”.

The financial system appears resilient, the IMF paper said, but close monitoring amid tightening financial conditions will be important.

The paper also highlighted:

• Medium-term fiscal plans should stick to a consolidation path in the face of significant spending pressures
• Tax reform could strengthen economic efficiency and public revenue
• The current RBA review presents an opportunity to reaffirm the inflation targeting regime and revisit the central bank’s governance arrangements and decision-making processes
• Greater structural reforms are needed to address a slowdown in labour productivity
• Upgraded climate change mitigation targets should be supported by strong policy action BLOOMBERG