Reserve Bank of Australia warns economy to slow sharply as inflation soars

AUSTRALIA’S central bank on Friday warned inflation was heading to three-decade highs requiring further hikes in interest rates that would slow growth sharply, making it tough to keep the economy on an “even keel”.

In its quarterly Statement on Monetary Policy, the Reserve Bank of Australia (RBA) jacked up its forecasts for inflation, downgraded the outlook for growth and foreshadowed an eventual rise in unemployment.

Yet even with further increases in rates, inflation was not expected to return to the top of its 2-3 per cent target range until the end of 2024, pointing to a long period of pain ahead.

“It is seeking to do this in a way that keeps the economy on an even keel,” said RBA Governor Philip Lowe in the introduction to the 66-page statement.

“The path to achieve this balance is a narrow one and subject to considerable uncertainty.”

The central bank has already raised its cash rate four months in a row, taking it from an emergency low of 0.1 to a seven-year high of 1.85 per cent and is flagging more to come.

“The Board expects to take further steps in the process of normalising monetary conditions over the months ahead, but it is not on a pre-set path,” said Lowe.

Markets see rates reaching 3.0 per cent by Christmas and peaking around 3.30 per cent in April next year.

The hawkish outlook reflects the fact policy makers have been badly wrong footed by inflation which has surged on the back of rising costs for energy, food and construction.

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The RBA has had to lift its forecast peak for headline inflation to 7.75 per cent, when as recently as May it had tipped 5.9 per cent.

Core inflation is seen topping out at 6 per cent by the end of this year and then declining only gradually to 3 per cent by late 2024.

Lowe said these high levels risked getting built into wage- and price-setting behaviour, though so far longer-term inflation expectations had remained anchored to the 2-3 per cent range.

Forecasts for economic growth this year were slashed by a full percentage point to 3.25 per cent, while 2023 and 2024 were trimmed by around a quarter point to 1.75 per cent.

“A higher cost of living, rising interest rates and declining house prices are expected to weigh on growth and spending,” said Lowe.

After a bumper 2022, house prices are now on the retreat with Sydney seeing the fastest falls in 40 years.

The bank has also been surprised by the strength of the labour market, which saw unemployment hit a 48-year low of 3.5 per cent in June.

The RBA now see the jobless rate falling to 3.25 per cent by the end of this year, before rising slowly to 4 per cent by late 2024.

Annual wage growth is expected to pick up to 3.0 per cent this year and 3.6 per cent next, though that would still lag inflation. Wages could grow 3.9 per cent in 2024 which would be the fastest in many years.

All these forecasts are based on the assumption that interest rates rise to around 3 per cent by the end of this year, and decline a little in 2024. REUTERS