The risks holding back more rate cuts

By Nico Louw

First published in the MRC’s Watercooler newsletter. Sign up to our mailing list to receive Watercooler directly in your inbox.

The RBA’s commentary this week didn't give those with a mortgage much to look forward to.

The question being asked on Tuesday was whether the RBA was “one and done”. For the foreseeable future, that seems likely.

While the market on Tuesday was pricing in another three rate cuts by early next year, including a strong chance of one by May, the RBA Governor called that unrealistic. 

The case for a rate cut was there, but it was tenuous. The RBA cut rates before inflation has actually fallen into the target band of 2-3 per cent and its forecasts still don't get us back to the middle of that band by the end of their forecast period in 2027.

The odds of a rate cut at the next meeting in April would have to be close to zero.

The outlook gets more concerning when you look at the detail of the RBA’s forecasts and the key risks they outline. 

The RBA identifies productivity growth as a key risk to the inflation outlook. They forecast that productivity growth will pick up over the next two years, but note this is far from certain. If productivity growth remains weak and wages continue to grow, inflationary pressure will build and the chance of further rate cuts will fall.

Addressing productivity growth is vital to Australia’s long-term prosperity and living standards, which is why the Menzies Research Centre will shortly be releasing a report with practical steps the Government can take to get productivity moving again. 

An equally concerning risk is Government spending. 

This week the MRC released a report on The Inflationary Cost of Big-Spending Governments, which showed how government spending since the last election is leading to higher inflation today and has delayed its return to the RBA’s target band.

Commonwealth and state governments spend a combined $1 trillion per year and their appetite for more spending shows no signs of slowing. 

And there’s no doubt that much of this spending is wasteful or inefficient.

As foreshadowed earlier this month by our Executive Director David Hughes, in another upcoming report the MRC will examine ways to reduce waste and improve efficiency across the Commonwealth’s 360,000 employees and $730 billion in spending.

Examples of questionable spending we have found since include $3.47 million to “fundamentally re-make Australia’s colonial legal institutions to remove the harm they currently do to Indigenous people and communities” and $660,000 to fund an Indigenous and Torres Strait Islander “interdisciplinary dance collaboration” that provides “a powerful rebuke of colonial amnesia” and “replaces tired narratives of trade and Empire with truth, resistance, and resilience”.

The risk of more wasteful spending that increases pressure on inflation is high as we head into an election.

What many won’t know is that the RBA doesn’t take this into account in their forecasts — they only include the impact of spending decisions that have actually been taken. In fact on Tuesday they upgraded their forecasts for the impact of government spending compared to just three months ago, to take into account more spending at mid-year Budget updates.

Economist Chris Richardson this week summarised the risk well when he pointed out that by cutting rates now, the RBA has effectively removed the last guardrail against wasteful spending by benching itself as a constraint against more spending.

The prospect of a big-spending pre-election Budget by the Government should worry all Australians, not just mortgage holders. Significantly higher spending will put upward pressure on inflation for everyone, as well as reducing the chances of more interest rate relief in the coming months. 

This is why we still expect the Government to avoid a Budget and call an early election. In addition to not having to reveal a sea of deficits, this would also avoid the risk of the RBA decision a week after the Budget (scheduled for 25 March) including commentary on the effect of Budget spending.

Unfortunately, skipping the Budget doesn’t mean skipping the spending. Election commitments still need to be paid for eventually and all Australians will pay the price if Government spending isn’t reigned in.