The Reserve Bank expects inflation to peak at 8% in the December quarter, propelled by rising energy costs, while wage increases are only forecast to reach a top rate of 4% by June 2024.

In its latest quarterly statement on monetary policy, released on Tuesday, the central bank confirmed the annual consumer price index would accelerate from the 7.3% recorded for the September quarter. If achieved, 8% would be the highest since the first three months of 1990 when it was 8.7%.

The updated estimates include the RBA’s prediction that the Australian economy will slow from 3% growth in 2022 to 1.5% in each of the next two years.

Interest rates will likely continue to rise to subdue inflation, with the core measure the RBA watches most closely expected to peak at 6.5% by December. Even by the end of 2024, the so-called trimmed mean gauge will likely still be outside the RBA’s 2-3% target range of 3.25%.

Wages were growing at an annual pace of 2.6% in June this year, implying a drop of 3.5% when inflation of 6.1% at the time was deducted. The RBA expects CPI to ease to 6.25% by June next year, outpacing the forecast wage price index rise of 3.75%.

A year later, CPI should be at 4.25%, still faster than the predicted 4% rise in wages in the 12 months to June 2024.

While inflation is a global issue, the RBA made Australia the first among wealthy nations to slow the pace of interest rate rises when it lifted the cash rate by 25 basis points in October.

That move snapped a burst of four consecutive half-percentage point hikes, with the banks following up with another 25 basis point rise last Tuesday. By contrast, central banks in the US and the UK have both lifted their main rates by 75 basis points this week, maintaining their pace of “super-sized” increases.

“The Board is focused on returning inflation to target and establishing a more sustainable balance of demand and supply in the Australian economy,” the RBA said. “To achieve this, the Board expects that interest rates will need to increase further.”

As in RBA governor Philip Lowe’s comments on Tuesday, the bank remains open to increasing the cash rate “in larger steps” if need to reduce inflationary pressures. It also prepared to pause in lifting the interest rate “ if the situation requires” so.

Still, the “the task of bringing inflation down has been made more difficult by the escalating price pressures in the domestic electricity and gas markets and another round of floods that has damaged the domestic food supply”, the RBA said.

“Measured electricity prices in the CPI increased by 3% in the [September] quarter,” the RBA said. “By contrast, underlying electricity prices (excluding the effect of rebates) increased by 15.5% .”

“Gas prices, where no significant rebates were provided, increased by 10% in the quarter to be nearly 17% higher over the year,” it said, adding that higher wholesale future prices indicated there will be “further strong increases in retail electricity and gas prices in 2023”.

The RBA’s inflation forecasts are slightly higher than those contained in the federal budget that was released on 25 October and did not include the September CPI spike.

Most other predictions are similar. The RBA, for instance, expects the jobless rate to remain around its current level of 3.5% until mid-2023 and only creep higher to 4.25% by the end of 2024. The budget predicts an unemployment rate of 4.5% for both the end of the 2023-24 and 2024-25 fiscal years, before easing to 4.25% a year later.

Reserve Bank explains ‘forecast miss’

John Hawkins, a former senior official within both the RBA and Treasury and now a lecturer at the University of Canberra, said the bank was notably pessimistic about the global economy. It now expects growth to slow to “well below” pre-pandemic levels.

The RBA noted iron ore prices were down 23% since its August statement, while LNG prices were off 24% in Asian spot markets. Coking coal, used in steelmaking, has since had its price jump by two-thirds.

Growth in China, easily Australia’s biggest trading partner, “is expected to remain modest, given a range of significant headwinds including a weak property sector and the authorities’ approach to managing Covid-19 outbreaks”, the bank said.

“While growth in 2023 is expected to be much stronger than in 2022 (conditional on there not being a repeat of lockdowns as disruptive as Shanghai’s experience this year), Chinese GDP is still expected to remain well below its earlier trajectory,” it said.

Hawkins said inflation may decline quicker than the central bank was predicting “given some of the drivers of higher inflation have already gone into reverse”. The caution, though, might be a consequence of the RBA – and its global counterparts – previously miscalculating how fast price pressures would mount.

The RBA described the mistake in a special “What Explains Recent Inflation Forecast Errors?” section of Friday’s statement.

“As one of the largest economic shocks in a century, the inflationary effects of the pandemic-driven imbalance between supply and demand for goods both globally and domestically played an important role in the forecast miss,” the bank said.

“Other unforecastable shocks – such as the effects of Russia’s invasion of Ukraine and the Australian east coast floods – also contributed.”

To limit the risk of future errors, the bank has made “upward adjustments [in its models] based on liaison, surveys and international experience”.

Hawkins welcomed the RBA’s “self-criticism”, saying it showed the board was “keen to learn from past mistakes”, even if no other forecasters predicted how much inflation would accelerate.



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