They say a week is a long time in politics, and it turns out that a month is an eternity when it comes to economic forecasts.
Just under six weeks ago, Treasurer Josh Frydenberg presented a pre-election budget.
A few weeks later, the Treasury and the Department of Finance independently signed off on a pre-election budget outlook with essentially the same economic forecast.
Today, just a month later, the Reserve Bank released its latest forecast, which is a stark departure from its previous outlook, as well as the much more recent Treasury forecast.
The key change, of course, concerns inflation: the main reason the Reserve Bank quickly moved from, as recently as the end of last year, expecting no rate hike before 2024, and in February saying he would be “patient” on tariffs, to implement the first hike in more than 11 years this week.
While, in its previous quarterly statement on monetary policy in Februarythe RBA expected consumer price inflation to peak at 3.75% in June, he now expects inflation to hit 5.5% this quarter and continue to rise to 6% by the end of the yearpartly due to the expiry of the six-month reduction in excise duties on motor fuels which is currently holding down gasoline prices.
After expecting his preferred measure of consumer prices, which excludes the most volatile moves, to peak just above target in June at 3.25%, he now expects this figure will reach 4.75% by the end of the year.
More worrying for the central bank, this measure is not expected to fall back to the top of its target range of 2 to 3% before June 2024, a point underlined by RBA Governor Philip Lowe during his press conference on Tuesday.
And even this forecast is based on the assumption that interest rates will increase several times over the next two years.
Traditionally, the RBA has used market prices as the basis for the interest rate path used in its forecasts, but traders are pricing in a spot rate well above 3% next year, which almost all local economists consider highly unlikely.
So this year, in a break with past practice, the RBA adopted a trajectory for the cash rate “broadly in line with expectations derived from surveys of professional economists and financial market pricing”.
Big bank economists’ forecasts range from 1.6% to over 3% for peak cash rates over the next few years, with RBA Governor Philip Lowe saying a longer-term cash rate should at least correspond to the midpoint of the inflation target, which is 2.5%.
The key takeaway is that these forecasts suggest it will take a combination of much higher interest rates – likely up at least another 1.5 percentage points over the next couple of years – as well as a resolution of some of the supply chain disruptions caused by Russia’s invasion of Russia. Ukraine and China’s COVID-19 outbreaks before consumer price inflation comes under control.
Wage increases will take time to outpace inflation
Besides rising interest rates for borrowers, the bad news for most of us is that until the rise in prices slows, our wages are unlikely to follow.
The most recent wage price index for December showed an annual increase of 2.3 percent.
Inflation was 3.5% during the same period, so workers who did not receive bonuses or promotions saw the purchasing power of their wages decline.
Even including bonuses and promotions, a broader measure of wages still lags price increases: 3.3 versus 3.5%.
The next pay figures are due out in just under a fortnight and the RBA expects pay rises to resume, but nowhere near as fast as prices.
While inflation should end the year at 5.9%, wages should only have increased by about half (3%).
Even including bonuses, promotions and moves to higher-paying jobs, workers should see a total wage increase of 4.4% for every hour worked.
The good news is that by the middle of next year, the Reserve Bank expects increases in the average hourly wage to finally outpace the rise in the cost of living, and by the By the end of next year, the wage price index is also expected to outpace inflation, meaning you won’t need to change jobs or get promoted to stay ahead.
Falling house prices are a ‘downside risk’
Of course, it depends on the accuracy of the RBA’s forecasts, and we had a perfect illustration this year of how difficult it is for economists to forecast even a month ahead, let alone a year or more.
The Reserve Bank itself warns of risks to its forecast.
One of the main ones is the response to rising interest rates, particularly in the housing market.
In his recent Financial Stability Review, RBA modeling warned of a possible 15% drop in house prices if interest rates increased by 2 percentage points.
“The sensitivity of asset prices to rising interest rates is uncertain, particularly in the case of housing, where prices are high relative to incomes,” the bank notes in the report.
“While many households would be well positioned to absorb higher interest charges without sharp spending adjustments, some households have low savings reserves and high debt relative to income, and their spending may fall more sharply than others.”
The RBA already has a much more pessimistic forecast for household consumption next year and the year after than the Treasury budget.
This is a key reason why its forecast for economic growth (GDP) is also about half a percentage point lower than the Treasury’s forecast for the next two fiscal years, at 3.1 and 2%.
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