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The Dire Warnings on Inflation-Busting Are Coming True

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The Reserve Bank of Australia’s surprisingly big interest rate hike is an acknowledgment of how far behind it has fallen in the struggle against inflation. The central bank now appears intent on wringing stimulus from the economy as quickly as possible. Having started late on this vital endeavor, officials may have little choice but to unleash more jumbo hikes. 

RBA Governor Philip Lowe committed to “doing what is necessary” to control inflation. He has lifted borrowing costs twice in consecutive months, both steps exceeding the forecasts of most economists. The bank’s projection for much of last year that rates might not climb until 2024 looks like a larger mistake with every week that passes. The penance is a series of shocks: Bond yields soared Tuesday and stocks declined. Officials will need to be careful not to overdo it lest they engineer too pronounced a slowdown.  

The RBA lifted its main rate by 50 basis points to 0.85% and, describing that level as still very low, vowed further withdrawal of accommodation in the months ahead. There was little indication of an end date for tightening, or data that would guide such a decision. The only hint we got is that officials expect inflation to retreat toward the bank’s 2%-3% target in 2023. Consumer prices rose 5.1% in the first quarter. 

Lowe did make an effort to frame the decision as a return to normal after the pandemic — even if the magnitude of the step was unusual. “The resilience of the economy and the higher inflation mean that this extraordinary support is no longer needed,” he wrote. If the objective is to speedily return monetary settings to neutral, a vaguely defined point that neither brakes nor adds fuel to the economy, then a handful more hikes seem necessary. (The RBA’s assistant governor, Christopher Kent, indicated last month that neutral lies between 2%-3%.) 

There’s little sign that the momentum behind the economy is going to dissipate on its own. Retail sales are buoyant. The jobless rate is the lowest in almost half a century, while gross domestic product hummed along at an annual pace of 3.3% last quarter, faster than anticipated. A gauge of inflation published by the Melbourne Institute jumped to a 14-year high in May. 

In stepping on the gas, the RBA is in line with central banks globally. The Federal Reserve lifted its main rate by 50 basis points in May and has said increases of the same magnitude await in June and July. The Bank of Canada pushed rates up by half a point recently. The ECB wants to end negative rates by the end of the third quarter. On one level, the RBA is in good company.

It’s forward guidance that’s really let the RBA down. For much of last year, the authority was saying that rates might not need to rise for another few years, an error that Lowe almost rejoiced in last month when pressed by reporters. “Thankfully, we were wrong,” he said, pointing to a fast pickup from a Covid-induced recession. 

The RBA has tasted how uber-specific forms of forward guidance that reach far into the future can go awry. While the 2024 timeline for hikes did have caveats, markets were more focused on the date. This is a classic trap: For forward guidance to be effective, it can’t be too vague. Yet there must be sufficient qualifiers, so that investors understand it’s not a promise. This distinction works in theory; in the noise of the modern political economy, made even more complicated by the pandemic and surprising vigor of inflation, practice can be another matter. “Central bankers are still learning how to balance the trade-off between commitment and flexibility,” former Fed Chairman Ben Bernanke wrote in his new book, “21st Century Monetary Policy: The Federal Reserve from the Great Inflation to Covid-19.”

Still, old habits die hard. Just last month, Lowe told a press conference that quarter-point increases, the first of which was undertaken in May, should be considered “business as usual.” There was nothing untoward about that move, even though it exceeded forecasts. On Tuesday, Lowe signaled standard operating procedure won’t cut it, at least for a while. Abnormal is the new black at the RBA.

More From This Writer and Others at Bloomberg Opinion:

• Who’s to Blame for a Recession, Biden or Powell?: Daniel Moss

• The Red-Hot US Labor Market Is Suddenly Not: Robert Burgess

• Sunak’s Helicopter Drop Makes BOE’s Life Easier: Marcus Ashworth

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was executive editor of Bloomberg News for economics.

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