It is an article of faith in Sydney’s financial district that the RBA strives to avoid entanglement in electoral politics. And until a few weeks ago, most economists confidently predicted that Governor Philip Lowe would wait until the votes were cast in the May 21 ballot. That calculus changed dramatically when figures released last week showed the pace of price increases had exceeded the bank’s 2-3% target. With the RBA setting rates independently of Canberra, inaction risked being viewed as political – a characterization that is anathema to currency chiefs around the world.
No candidate will thank the RBA. The opposition Labor Party will put Prime Minister Scott Morrison’s centre-right coalition on the defensive against more expensive mortgages. Yet Labor knows that if it wins in three weeks, its honeymoon could be ruined by multiple rate hikes and stubbornly high inflation. Morrison placed economic management at the center of his defense against Labour. The Prime Minister can see the rate hike as validation of the strength of the recovery. But overheating – implicit in the RBA’s move – makes it vulnerable. Morrison should have been careful what he wished for.
For its part, the RBA appears to have misjudged both the speed of the economy and the potential for a rapid acceleration in inflation. It was only this year that the bank admitted that a hike in 2022 was plausible. Lowe had said for much of last year that there might not be a need to raise rates until 2024. Looking back, with borrowing costs rising in advanced and developing economies, such a schedule seems ridiculous. Few downstairs were covered in glory on Tuesday.
What was the RBA thinking? In its mistakes – and their explanations – the central bank fits well into the global mainstream. Stung by years of below-target inflation, Lowe had become skeptical of forecasts that an inflation spiral lurked behind every good growth number. He wanted to deal with basing policy on inflation outcomes, not just projections. The potential reward was to drive down unemployment to levels not seen in generations. It was a historic opportunity.
This time, however, inflation soared. The rapid rebound from the pandemic-induced recession, massive monetary assistance during the crisis and supply chain constraints afterwards proved the worries right. Like central banks around the world, the RBA is likely to rush to reach neutral, a loosely defined zone that neither slows nor hinders the economy. If Lowe needs to go further and constrain the economy, he probably will. New official forecasts show core inflation reaching 4.75% this year, well north of the target. “The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time,” Lowe said in a statement. “This will require a further rise in interest rates over the coming period.”
This decision is one for the ages. Not only is the RBA starting from scratch and doing it during an election campaign, but the bank has managed to mislead even the forecasters who tipped the scales today. This camp has largely predicted a 0.15% move, with a bigger step coming in June. People who thought officials would expect up to 50 basis points in June.
Lowe may not please anyone. This makes the step no less vital. With both sides of the political aisle pledging to overhaul the central bank, life is set to get even more interesting for the RBA.
More from Bloomberg Opinion:
• The RBA hike is a no-brainer. Will politics interfere? : Daniel Moss
• The Fed must do more than raise interest rates: Mohamed El-Erian
• Why the Fed continues to underestimate inflation: Allison Schrager
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was Bloomberg News’ editor for global economics and led teams in Asia, Europe and North America.
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