The Reserve Bank faces a critical decision on whether to raise the cash rate in its meeting on the first Tuesday of August, and opinions are divided.
Redom Syed (pictured above), the director of brokerage Confidence Finance, provides contrasting arguments on why the RBA will or won’t raise the interest rates as the central bank navigates the delicate balance between controlling inflation and fostering positive economic growth.
“Overall, it’s a tough choice for the RBA; there’s merit in both a pause and a raise,” Syed said. “The RBA meets every month, so a pause on the back of the latest inflation data is the most likely outcome in this meeting but that does not mean further rate rises down the road,” Syed said.
“Either way, we’ll know at 2.30pm on Tuesday.”
Why an interest rate rise makes little sense
Reason one: Declining inflation
After 12 rate rises in a little over a year, the RBA’s hawkish attempts to curb inflation have been well-documented and routinely criticised.
However, with last week’s inflation data coming in lower than expected, many economists have revised their expectations with only 14% now expecting a rate rise.
“Inflation has nose-dived in Australia, and this is great news for Aussie mortgage holders,” Syed said.
Inflation came in at 0.9% for the quarter in terms of trimmed mean inflation, the RBA’s preferred measure when it talks about its 2% to 3% target inflation band.
For the year, it’s been around 6% but Syed said that this figure was skewed by 2022 data.
“In the second half of 2022, inflation was around 7% but in the first half of this year, it’s been around 4%. When you combine it together, you get that annualised 6% figure reported last week,” Syed said.
Reason two: The RBA is ahead of schedule
With the inflation data in mind, Syed said the RBA was well ahead of its scheduled pathway to bring inflation down and unemployment was in line with its forecasts.
“There’s less pressure to increase interest rates since the pace of inflation is coming down so quickly,” Syed said. “In fact, quarter-on-quarter shows that it’s halved inside a year, and it suggests the trajectory of inflation is down and may come under band in 2023.”
This is despite the monetary policy of central banks internationally trending towards further rate rises, with the US Federal Reserve (5.5%) and the Bank of England (5.0%) raising rates at their last meetings while the Reserve Bank of New Zealand left the nation’s cash rate unchanged at a higher rate (5.5%).
“The RBA said they’ll be more patient than their international peers – now it’s time to show it,” Syed said.
Reason three: Positive economic growth
The third reason for the RBA to pause rates, according to Syed, is to ensure that there is positive economic growth in Australia.
The latest data showed that for quarter-on-quarter growth was marginally positive at 0.20% for the start of 2023, and negative on a per capita basis.
Importantly, this data does not include the last two rate rises, which are likely to further slow the economy.
If the Australian economy was a car and the RBA the driver, it makes sense to pump the brakes on inflation and raise rates to keep everything on track. However, the RBA needs to be careful not to raise rates too much or the car will start to go backwards.
“The goal here isn’t to induce a recession and force unemployment higher,” Syed said. “It’s to get inflation down, while keeping growth positive. And that’s already happening. Quicker than they expected and it’s time to take a breath.”
Three reasons why a rate rise is a no brainer
Reason one: Inflation is still too high
While falling, inflation is still well above the RBA’s target band.
Syed said this continued to erode Australian living standards with the cost-of-living crisis continuing to take a toll on the everyday lives of Australians.
Australian mortgage holders needed to work for at least 18 days in order to meet their monthly loan repayment, a research by Canstar revealed, while groceries and other expenses continued to rise.
A sizeable part of the population are even delaying having children because of the cost of living, so prolonging the problem could have long-term consequences on the economy.
Syed said this was “unacceptable” for a central bank and it may choose to reach its peak sooner rather than later.
Reason two: The strong labour market
Syed said another reason the RBA might choose to raise interest rates was because the labour market had performed “incredibly strongly”, with unemployment remaining at 3.5% and over one million more people working than pre-COVID.
“In fact, since rates began rising in mid-2022, over 400,000 people have become employed. This is adding to incomes, and putting pressure on inflation,” Syed said.
On top of that, with more people producing, asset prices have continued to rise.
“This could potentially make Aussies feel wealthier and increase their spending as a result, further fuelling inflation,” Syed said.
Reason three: Other central banks are doing the same
With other central banks raising rates globally, Syed said that Australia keeping a large interest rate differential with the world would lead to further inflation being imported here, contrary to the goals of getting inflation down.
“The central bank’s mandate is to get inflation to 2% to 3%, maintain full employment and enhance the welfare and prosperity of the Australian people,” Syed said. “Letting inflation remain out of band for the next 18 to 24 months, while having the strongest labour market in 50 years is a breach of this mandate.”
The verdict
While both arguments are compelling, Syed does have a verdict on which way the RBA will go on Tuesday.
“On balance, I believe the arguments for pausing outweigh the arguments raising the cash rate,” Syed said. “That said, both decisions do have merit.”
What do you think the RBA’s verdict will be? Comment below.
