Former Reserve Bank governor Ian Macfarlane believes inflation is unlikely to settle back into its 2 to 3 per cent target range in the foreseeable future and a rate of 4 or 5 per cent in the medium term is more likely.
“If we want to have a cash rate that is positive in real terms, a ballpark estimate could be a neutral cash rate of 5 per cent,” Macfarlane said.
Speaking at the Morgan Stanley Australia Summit yesterday, Macfarlane agreed with the view that supply-shock inflationary pressures are transitory but said growing wage pressure could feed into more sustained underlying inflationary pressure.
He said central banks were in uncharted territory, coming off such a long period of low cash rates.
“Long periods of expansionary monetary policy always lead to excess somewhere. In the US we usually find it in the financial markets. In Australia it is the housing market,” he said.
Macfarlane noted the big difference between the financial market’s outlook for the cash rate – 3 per cent by the end of the year and 3.5 per cent by the middle of 2023 – and the banks’ outlook.
A Westpac forecast published on June 3, before the latest cash rate hike, is for the cash rate to reach 1.75 per cent by December and 2.25 per cent by June next year.
“The banks are flagging that they could have problems if the cash rate rises above those levels. They have looked at their mortgage books and estimated how many borrowers will have mortgage service costs that exceed their servicing ratios,” Macfarlane said.
“You can’t allow the marginal mortgage borrower to determine rates and the RBA won’t be held hostage by the problems mortgage borrowers have. But it won’t ignore the problems either.
“The good news is that most people don’t have a mortgage and most of those that do are ahead with their repayments. There is a lot of money in offsets.
“When rates go up Australian households keep servicing their mortgages and cut back on their spending. That is part of how monetary policy works.
“But there will be a limit to how far the RBA can go and maybe they will have to call off rate increases before they get to the level that would otherwise.”
Macfarlane said that when interest rates are in the 2 to 3 per cent range they are high enough to be a positive for the economy but not so high that they have a big impact on business planning.
“If the rate does get stuck at 4 or 5 per cent, it creates an environment where businesses want to put up their prices and workers want to get more wages. There is upward pressure in the economy all the time.”