High interest rates are here to stay

I'm taking a break from writing about energy and US politics this week because I think it's time to take another look at the Australian macro situation. That means more about inflation, which in my view is still the issue today. It's especially relevant considering that last week, the US Fed, UK's Bank of England, and Sweden's Riksbank all cut rates.

Unfortunately for those with a mortgage, the Reserve Bank of Australia (RBA) recently explained that it's not expecting "inflation returning sustainably to the midpoint of the target until 2026", and that it's going to ignore the headline figure because of the government's "cost of living" meddling.

So, no rate cuts here for some time:

"Headline inflation was 2.8 per cent over the year to the September quarter, down from 3.8 per cent over the year to the June quarter. This was as expected due to declines in fuel and electricity prices in the September quarter. But part of this decline reflects temporary cost of living relief. Abstracting from these effects, underlying inflation (as represented by the trimmed mean) was 3.5 per cent over the year to the September quarter."

Following Donald Trump's election in the US, market pricing moved from a 62% chance of a rate cut at the February meeting to no cut until at least May. That's because Trump's policies are likely to raise real interest rates, with spill-over effects for Australia potentially even pushing a cut back as far as August.

In that context, I think it's sensible that the RBA is talking down the prospects of a rate cut. Central banks have a tendency to move too late and when they do, to go too small. That's because they're relatively risk averse, and wouldn't dare make a move if there was a chance that they'd have to reverse course later.

That means they tend to stay put for longer than they should, because no decision is better than a wrong decision, at least in terms of their career prospects. Remember Philip Lowe?

But the RBA doesn't have much of a choice this time, either. One of the last advanced-economy central banks to act on inflation, the RBA also had one of the more timid responses. Even with most central banks having cut their cash rates multiple times, Australia's estimated policy restrictiveness is only above Sweden:

This is a crucial measure that many pundits miss because they don't understand how monetary policy works. That wall of shame includes at least two names: former Labor politician Craig Emerson, who seemingly doesn't understand that monetary policy is a nominal phenomenon and that it's perfectly possible to have too-loose monetary policy and a weak economy being decimated by real factors (hello, 1970s and 80s); and economic commentator Stephen Koukoulas, who has been calling for 100 basis points worth of cuts this year on a technicality.

Thankfully, the RBA is 'looking past' the distortions that Koukoulas wants it to ignore and is focused on core inflation, which strips out "volatile" components like food and energy. In Australia, core inflation is still running well ahead of other countries that have more restrictive monetary policies:

The RBA isn't belittling people when it strips out two things they care a lot about, like food and energy. It's just trying to get a read on inflation so that it can determine whether its current policy position is appropriate or not. Removing volatile items, especially when one of them is being actively manipulated by the government, helps it do that.

I also think it's important to clarify that the cash rate is not a good indicator of how loose or tight monetary policy is; if it was, Argentina – where the benchmark interest rate is 35% – would have some of the tightest money in the world right now. Yet annual inflation is running at 209%.