Election rate rise now almost a certainty

The Reserve Bank of Australia will almost certainly be raising official interest rates this Tuesday – most likely by a full 0.4% – and it is likely to keep the rate rises coming once the election is over.

There was a chance that the RBA would be intervening in the election campaign but the official arrival of 5.1% inflation for the March quarter has made that intervention as close as you can get to a certainty.

What is worse is that the inflation households actually feel – non-discretionary price rises for fuel, food, housing, education and health – is flying along at 6.6% in the year to March, with more to come as fuel rises continue to filter through as transport costs.

There is simply no credible alternative but a swift and solid official response to a reality that confronts us than a move upwards from the current “emergency” 0.1% official rate, which is now likely to become an obscure trivial pursuit question in a few years.

No opportunity to sit on hands and wait

The idea that RBA governor Dr Philip Lowe and his fellow board members could sit on their hands after inflation has uncomfortably blown right through their comfort range just because there is an election running is a fantasy.

Similarly, the chances of a smaller “interim” rise of, say, 0.15% to take the cash rate to 0.25% is also a chance but would be a missed opportunity.

The chances of going too small in the normalising change of direction risks more and larger rises down the track – again, not something that an independent RBA board would contemplate.

So, the odds are now strongly in favour of a decisive rise of 0.4% on the current 0.1% to take official rates to 0.5%, giving the RBA the best chance to reduce inflationary pressures and get back ahead of the curve.

US already half-way to a recession

Even that may be too little, too late given the strength of inflationary forces both here and in the United States – something shown by the extraordinary 1.4% fall in first quarter US GDP which means the world’s biggest economy is half way to recession already.

As Clifford Bennett, Chief Economist at ACY Securities and one of the very early voices last year warning of an inflationary surge, put it: “The real twist in all of this and one that financial markets continue to miss is that in nations like the USA and Australia we are most definitely going to experience stubbornly high inflation and one of the most aggressive interest rate hiking cycles we have ever seen – simultaneously hitting consumer and business spending power.’’

“These economies are going to be crunched severely, due to higher interest rates actually having little impact on inflation over the next 12-18 months.”

“This is very serious and has the risk of driving the US economy into recession.”

“Similarly, it even raises the risk of a recession in Australia to as high as 30% over the next year,’’ he added.

Central banks will always try to prevent recessions

You can argue with Mr Bennett’s analysis but the fact is that the central banks both here and, in the US, won’t hesitate to act to reduce the chance of recession.

That means that unwanted side effects of raising rates such as political implications or rising numbers of households encountering mortgage stress will have to take a back seat.

The same also applies to wages and jobs, which will remain a key focus but in the context of a potential recession.

There is simply no time to wait to see if wage rises have started to catch up with inflation, because, in real terms, wages have been falling for quite a while.

The difficulty businesses are having in getting workers may well lead to wage rises over time, but not enough to counteract non-discretionary price rises that are leaving a big dent in the pockets of millions of Australians.

Interest rates are a very blunt instrument to control inflation, particularly imported inflation, but they are also the fastest and most effective way of reducing demand.

So, expect the RBA to pull on the rate rise lever on Tuesday and keep periodically pulling on it for the rest of the year at least because the inflation genie is well and truly out of the bottle and will be difficult to contain from here if rates remain at emergency settings.