Philip Lowe, governor of the Reserve Bank of Australia (RBA), will preside over one of the institution’s most critical and sensitive meetings on Tuesday when his board meets to decide whether to lift the official cash rate during the election campaign.
The high-stakes decision follows last week’s spike in both core and headline inflation to their highest levels in more than 20 years.
With so much riding on it, how does the RBA make its determination and what is the likely outcome?
Why is this decision so important?
The RBA hasn’t raised interest rates since November 2010, on the same day Americain won the Melbourne Cup. In other words, so long ago, few can remember it.
The last time the RBA lifted rates during an election was in 2007 when governor Glenn Stevens and his board hiked the rate by 0.25 percentage points to 6.75%. The move angered then prime minister John Howard who went on to lose his seat and the election.
Interestingly, the bank under the current governor Lowe waited until after the 2019 election before cutting the cash rate by 25 basis points to 1.25% in June of that year.
Scott Morrison has tried to blunt criticism that a Tuesday rate rise would be a poor reflection on his government’s economic management, blaming international factors for the high inflation. The treasurer, Josh Frydenberg, also pointed to previous comments by Lowe – including in last month’s board meeting – that the RBA wanted to see inflation and wage data before lifting the rate from its now record low of 0.1%.
Labor’s shadow treasurer, Jim Chalmers, meanwhile, says he’s “disappointed” that Frydenberg’s comments undermine the RBA’s independence. He and other Labor bigwigs are also hedging their bets, saying rates will rise a lot whether the first hike is in May or June. (Markets predict the rate will start climbing from May onwards.)
Who is making the decision?
The RBA board has nine members, all of whom have been appointed by the Coalition government in their current roles. Lowe, though, first joined the board as a deputy governor in 2012 during the Labor government led by Julia Gillard.
Women make up most of the board for the first time following the abrupt exit of deputy governor Guy Debelle in March, with Michele Bullock stepping up to fill the role.
Most non-officials have tended to be in business, including Mark Barnaba, deputy chair of mining giant Fortescue.
Ian Harper, director of the Melbourne Business School, held roles including the inaugural fair pay commissioner, and is also on the board of the right-leaning Robert Menzies Institute.
Wendy Craik, a former head of the National Farmers’ Federation, has also served in a number of government roles mostly appointed by Coalition governments, such as the now all-but-defunct Climate Change Authority.
Steven Kennedy, who is a board member by dint of being treasury secretary, is arguably the most political appointment.
James Morley, a University of Sydney professor who has worked on central banks from North America to New Zealand, said having the treasury secretary on the board set Australia apart from similar countries, such as Canada. Even so, the RBA is “still a fairly independent central bank”.
How is the decision made?
Unlike in the US or the UK, the RBA doesn’t disclose how board members vote.
The central bank itself says only that “consistent with the Reserve Bank Act, the board makes decisions by a majority of the members present, with the chair having a casting vote”.
Before the meetings, RBA staff provide board members with information about the economy to help them prepare. Staff, other board members and Lowe himself would often make presentations.
“So the idea that we kind of just go along and I say, ‘Interest rates aren’t changing,’ they say, ‘Yes. Yes, let’s go to lunch.’ That’s completely fanciful,” he said, adding that a “collective exploration … [is] the way that I like to do things”.
“By nature, I like to find the consensus that I need to explore through the shades of the murky wall of grey I live in, and that’s what we do,” Lowe said.
Mariano Kulish, another University of Sydney professor, who worked at the RBA until 2010, said the staff would typically provide a recommendation that would be discussed.
“I don’t know there’s been many instances in which the board has not gone with the staff recommendation or the governor’s decision,” Kulish says.
Warwick McKibbin, an Australian National University professor and former RBA board member, says when he was on the board a decade ago, members would get the bank’s briefing on the Friday ahead of the meeting, giving them the whole weekend and longer to mull their move.
McKibbin, unlike any of the current board members other than the two from the RBA, was a macroeconomic expert, and brought his own model to the meetings. (He also used to chat to the RBA staff on the sly before meetings until that bit of enterprising research was shut down.)
What will the verdict be?
Both Kulish and Morley are part of the ANU-based Shadow RBA board which recommends what the bank’s policy ought to be. Their view was “marginally in favour of cash rate rise” on Tuesday, although the verdict was only 53:47, Morley said.
McKibbin reckons that even though the RBA has not signalled any change of direction – which they normally would have, had they not been in some sort of witness protection since 22 March – they should move today.
He notes the US is about six months ahead of the RBA in terms of countering inflationary pressure. Now the US Federal Reserve (effectively their central bank) has been apologising for acting too late as inflation has soared.
As Morrison has been happy to highlight, the US consumer price index has climbed to 8.5%, much higher than Australia’s. Its underlying inflation rate is at about 5%, or 2.5 times the Fed’s 2% target, while Australia’s is at 3.7%, outside the RBA’s preferred 2% to 3% range, and rising.
Financial markets, though, have reduced their expectation of a rate rise, according to an ASX tracker. A separate measure also pared the prediction for a May rise while predicting a firm move of the cash rate target to 0.5% by the June meeting.
Why would the RBA hold back despite the CPI coming in at 5.1% for the March quarter? After all, that’s the highest level – excluding the introduction of the GST in 2000 – since the mid-1990s.
For one thing, the inflation push is so far coming from higher energy prices and supply constraints caused by Covid. What happens if, somewhat miraculously, those issues reversed – would the RBA cut interest rates, Morley asks?
“There is still good reason for the RBA to wait to June and raise the cash rate by 0.4 percentage points in response to the sustained and broad-based increases in prices,” Sarah Hunter, a KPMG economist, also a member of the RBA shadow board, said. “A June increase would allow the RBA to act outside the election campaign, and with the benefit of seeing the wage price index release [on 18 May] before deciding on the size of the upward movement.”
The RBA, though, would also be watching its overseas counterparts. Central banks in the US, the UK, New Zealand and elsewhere have already been raising rates, sometimes for months.
The longer Australia waits, the more pressure will be placed on the Australian dollar, Kulish notes. The currency has already dropped from the mid-70 US cent range to just above 70 US cents.
Further falls – which will be more likely the longer Australian interest rates stay near zero as others’ rise – will only end up importing more inflation, which the RBA will have to stamp harder on later, he said.