Warwick McKibbin says Australia’s central bank has been slow to react as supply pressures from Covid and war in Ukraine abate.

The director of the ANU Research School of Economics said it is becoming clear supply shocks from Covid and Russia’s war against Ukraine are abating. However central banks, including Australia’s, have so far been slow to react.

The World Bank’s latest data on energy and food prices show most commodities are back to prewar levels. Supply networks are also functioning with pre-pandemic efficiency, he said.

“There’s a deflationary shock coming from the supply side [as] supply has gone back to where it was,” McKibbin said.

“The central banks [are] still looking backwards and saying we need to raise interest rates.”

Australia’s headline consumer price index fell to an annual rate of 5.6% in May, the lowest level in 13 months, the Australian Bureau of Statistics said on Wednesday.

The US earlier this month said its consumer prices rose 4% in May from a year earlier. The month-on-month increase of 0.9% was the lowest in just over two years.

The eurozone economies posted a 6.1% inflation rate in May, the lowest in more than a year. The UK was one exception, with inflation unchanged last month.

Investors and some market economists expect the RBA will leave its official rate unchanged at 4.1% when the central bank’s board meets next Tuesday.

The RBA has lifted its cash rate a total of 4 full percentage points since it started tightening policy in May 2022, the fastest pace in decades.

Among the big four banks, the ANZ and Westpac both expect the RBA to hike rates by another 25 basis points in July and August. NAB says the odds are 50:50 for a rate rise next week, while the CBA says the probability is 40:60.

McKibbin, who is also a senior fellow at the Brookings Institution in Washington DC and was on the RBA board from 2001 to 2011, said he previously considered a peak RBA rate of about 4.5% would be enough to nullify the demand shock unleashed by the boost in government support and spending to keep the economy afloat during the Covid lockdowns.

RBA should pause rate rises as ‘deflationary shock’ sweeps global economy, former board member says

Warwick McKibbin says Australia’s central bank has been slow to react as supply pressures from Covid and war in Ukraine abate

Investors and some market economists expect the RBA will leave its official rate unchanged at 4.1% when the central bank’s board meets next Tuesday. The RBA has lifted its cash rate a total of 4 full percentage points since it started tightening policy in May 2022, the fastest pace in decades.

Among the big four banks, the ANZ and Westpac both expect the RBA to hike rates by another 25 basis points in July and August. NAB says the odds are 50:50 for a rate rise next week, while the CBA says the probability is 40:60.

McKibbin, who is also a senior fellow at the Brookings Institution in Washington DC and was on the RBA board from 2001 to 2011, said he previously considered a peak RBA rate of about 4.5% would be enough to nullify the demand shock unleashed by the boost in government support and spending to keep the economy afloat during the Covid lockdowns.

However, with gathering evidence of a pulse of rapidly shrinking price increases on the way from abroad, the RBA should now pause, he said. A cash rate at about 4% might turn out to be neutral in terms of keeping prices in check while not stalling the economy.

The central bank might yet need to lift rates again but only if a nascent increase in wages developed into a bigger wave, but there were reasons not to exaggerate the concerns.

“Wages are a small part of the Australian economy,” McKibbin said. As a proportion of gross output in Australia, the share was just 18% once you exclude the input from overseas’ workers.

The impact of interest rate rises take a year or longer to work its way through the economy so the RBA had time to wait to see if more increases were needed to quell inflation.

Should the RBA leave rates on hold, though, it was important the central bank made clear its reasoning and what might prompt it to resume rate increases.

“We’re going to get some surge in wages” after the Fair Work Commission’s 5.75% verdict for low-paid workers and other decisions, he said. “We’re probably not going to be cutting rates anytime soon but we certainly may not need to go as high as we were going to.”

Original Story By | Peter Hannam