Original Coverage & Source Attribution: www.theguardian.com
On Tuesday this week came the biggest news regarding inflation. No, not the Reserve Bank’s decision to raise interest rates; that will do barely anything (although it will most certainly raise unemployment). No, the most important news for inflation was that the US had launched limited strikes on Iran’s Qeshm Island.
This announcement came after word from the Iranian government that talks were under way to end the conflict – news that caused the price of oil to drop 11%. But the strike sent prices rising again, before traders took an optimistic stance ahead of Wednesday’s US midterm elections:
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This matters greatly for inflation because the Reserve Bank now forecasts inflation will be higher for longer than it forecast three months ago. In August it forecast by June next year inflation would be 2.8%; now it predicts it will be 3.7% and only get to 2.7% by December 2027.
And what is the big reason for the change?
Well, you will hear the RBA talk about capacity constraints and “excess demand”, but let’s not be so gullible as to swallow that story. We all know what has happened: oil prices.
Three months ago, the RBA predicted the price of oil in December this year would be US$81.20 a barrel; now it forecasts US$109.50 a barrel – 35% higher.
In August, the RBA thought by the middle of next year prices would be down to US$75.90 a barrel; now they think the price will be 26% higher at US$95.30.
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So let’s not play silly buggers. Inflation is forecast to be higher because the US and Israel’s war on Iran is going for longer than the RBA thought it would in both May and August.
And yet despite the RBA trying to convince everyone they are raising rates because inflation is also being driven by “excess demand”, the reality is no different now from May when Michele Bullock said, after the bank raised rates to 4.35%, that “we’ve seen a sharp increase in fuel and related commodity prices and this is already feeding through to inflation. The recent increases in interest rates will have no impact on this.”
If you disagree, just ask yourself what would have a bigger impact on lowering inflation: the five interest rate rises we’ve had this year, or if oil prices were to return to the pre-war price of $US$70 a barrel?
And yet here we go again. The RBA is determined to raise rates even though the main causes of inflation are out of their control. And yet again those in opposition parties and (unfortunately) many in the media are blindly calling for cuts to government spending as though that will help.
We know what comes from this combination of higher rates and cuts to government spending – we saw it across the Tasman Sea.
This week the Australian Council of Trade Unions produced research examining the difference between what has happened in Australia and New Zealand since the pandemic.
While the RBA raised rates from 0.1% in May 2022 to 4.35% in November 2023, the Reserve Bank of New Zealand raised their cash rate earlier and faster – from 0.25% in October 2021 to 5.5% in May 2023:
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The New Zealand government led by the newly elected National party also instituted an austerity program of cutting the public service and cancelling infrastructure projects to generate savings, such as the Auckland Light Rail.
The combination of high interest rates and government spending cuts was disastrous.
New Zealand was mired in recession or near-recession throughout 2023 and 2024. And after nearly a decade of lower unemployment than in Australia, New Zealand’s unemployment rate rose from 3.2% at the end of 2021 to now sit at 5.6%:
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If anyone wants to know why New Zealand’s interest rates are lower than Australia’s that is why – they slashed them in an ultimately futile attempt to avoid a recession.
But surely at least all the spending cuts and higher interest rates delivered lower inflation?
Nope.
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The funny thing about inflation driven by international factors such as wars, supply side shocks and companies increasing their profits is that interest rate rises don’t do much.
Imagine cutting government services, smashing borrowers, increasing unemployment and having a recession all for nothing.
Well wonder no more, because the RBA seems determined to not learn the lessons from across the ditch.
Bullock talked on Tuesday of how rising inflation is about excess demand and higher rates will help reduce that and the inflationary pressures.
But the RBA’s monetary policy statement noted that firms were reporting that “households remain value conscious and are trading down to lower-cost alternatives, weighing on profitability in discretionary sectors”.
Does households looking for bargains and cutting back on non-essential spending sound like “excess demand” to you?
By contrast the RBA noted “profits at consumer staples firms have been more resilient, while equity prices for Australian-listed energy companies have increased alongside higher oil prices”.
At least not everyone is struggling! While households have been hit by five interest rates rises, it is good that Coles and Woolworths and the oil and gas companies are doing OK.
Cripes. We really have a upside down way of viewing the economy.
