For better or worse, those making big policy decisions are “data driven”. It’s considered the most objective, fair way of enacting change that can leave some better or worse off. This Wednesday, the Bureau of Statistics will publish the September quarter CPI data. It will also coincide with the monthly inflation data for September. It will give the Reserve Bank a crucial insight into whether further tightening of monetary policy is necessary . More than that though, it’s the final piece of the puzzle in measuring how effective the policy to date has been.  A refresher The Reserve Bank has a brutally simple objective to use monetary policy as an instrument to drive inflation back down to its target range of between 2 and 3 per cent. That’s the inflation rate, central banks around the world believe, works best to keep the economy humming along. Measuring inflation is the easy part. RBA worried about ‘shock’ inflation RBA governor Michele Bullock worries that continuing global supply shocks may entrench inflation expectations and bigger price rises. It’s a weighted basket of goods and services and it gives us a sound reading on cost-of-living pressures in the community. It’s been too high of late. By increasing its cash rate, the Reserve Bank makes it more expensive for banks to borrow money. The banks then, to varying degrees, pass this higher cost onto mortgage borrowers. History shows renters also cop rental price increases, as landlords still paying off their mortgage pass on the added financing costs to their tenants. As home owners’ and renters’ disposable income is diminished, they start to re-prioritise their spending and cut back on discretionary items. This leads to lower demand in the economy and, in theory, lower prices for shoppers. But the Reserve Bank must be very careful not to reduce demand too much. If a whole bunch of people dramatically cut their spending, businesses across the economy will be forced to lay off staff as turnover falls. Those laid-off folks then cut their spending significantly and a downward spiral ensues. With this in mind, the Reserve Bank has been watching the unemployment rate and job vacancies closely as part of its overall assessment of the economy. The Reserve Bank has been watching the unemployment rate and job vacancies closely. John Gunn Savings are dwindling Curiously, the “data” has shown the economy has been resilient in the wake of a cumulative four percentage point or 400 basis point increase in interest rates ” the second steepest monetary policy tightening cycle in the bank’s history. It’s clear, however, that consumers are cutting back. In August, retail trade rose just 0.2 per cent month-on-month, according to the ABS. RBA keeps rates on hold but more hikes on the way The RBA has kept interest rates on hold, but more hikes are expected as 550,000 more people come off fixed mortgages. Consumer spending is the wild card for the Reserve Bank. “The outlook for household consumption also remains uncertain, with many households experiencing a painful squeeze on their finances, while some are benefiting from rising housing prices, substantial savings buffers and higher interest income,” RBA governor Michele Bullock said following the October board meeting. And those savings buffers are where it’s all at ” to speak loosely. The Reserve Bank’s latest Financial Stability review pointed to roughly 50,000 households at risk of drawing down all of their savings by March next year. The logic behind that is pretty simple household expenses are rising, incomes aren’t rising as fast, and savings buffers are being whittled down. The RBA review simply highlighted the pace at which these savings are falling. All things being equal, when these savings buffers are depleted, tens of thousands of households will move into financial distress. The trillion-dollar question, then, is how this force will ripple through the economy and whether it will lead to much higher levels of unemployment? Why this announcement matters So, we’re approaching crossroads. Does the Reserve Bank hold tight and assume the so-called “sticky” inflation we’re seeing in services subsides? What about ever-rising energy prices, war leading to higher fuel prices, and the housing shortage lifting rental prices? The bottom line is that, and lean in for this one, the “trajectory” of inflation needs to be on course with what the RBA has forecast. The March quarter CPI trimmed mean was 1.3 per cent. In the June quarter, it fell to 0.9 per cent. Based on these quarterly inflation numbers, the Reserve Bank believes annual inflation will return to between 2 and 3 per cent by the end of 2025. That also assumes no need to further tighten monetary policy, notwithstanding some kind of supply shock, like a big increase in the oil prices. But if Wednesday’s CPI comes in above 1 per cent, Houston, we have a problem. That is, higher inflation implies it will be more challenging to achieve the RBA’s 2025 inflation goal. Indeed, the longer inflation remains elevated, the RBA thinks, the less likely it is to retreat over the medium term as “inflation expectations” become unanchored or uncontrolled. Simply put, once the wider community loses faith that steep price increases at the shops will eventually stop, managing inflation becomes extremely challenging.   NAB chief economist Alan Oster says “we can see the RBA increasing [interest rates] by 25 points at its November meeting”. “We think the RBA decision is all dependent on the [third quarter CPI data] and what it means for their forecasts for a return to the target band by 2025,” NAB’s chief economist Alan Oster told The Drum. “A high trimmed mean say above 1 per cent in Q3 together with a still strong labour market will probably unsettle the RBA on the inflation timetable. “Hence we can see the RBA increasing [interest rates] by 25 points at its November meeting.” AMP’s chief economist Shane Oliver shared similar thoughts. “Of course, the RBA has long been flagging that ‘some further tightening in monetary policy may be required’ but its communications over the last week are somewhat more hawkish than flagged in the statement following its last board meeting,” he said. “This may just be jawboning and an effort by the new governor to highlight that she is just as determined to get inflation down as Governor Philip Lowe and so is all aimed at keeping long-term inflation expectations down. “But the clear message is that the risk of another rate hike is high and the RBA has flagged that it will be looking at things very closely at its November meeting.” AMP Capital Chief Economist Shane Oliver puts the chance of a recession at 50 per cent. John Gunn Dr Oliver said AMP had increased the risk of another rate hike from 40 per cent to 50 per cent, following the Reserve Bank’s latest communications. And, of course, given how many Australian households are already struggling to meet rental and interest payments, the fear is that if the Reserve Bank is forced to hike interest rates next month, it could be the interest rate straw that breaks the camel’s back. “Given the lags with which monetary policy impacts the economy, we would see another rate hike as dangerously adding to the risk of recession next year,” Dr Oliver said. “Particularly with the RBA’s own analysis showing that around one in seven households with a mortgage were already cashflow negative in July [where essential expenses including private health insurance, school fees and mortgage payments] exceed their income,” Dr Oliver said. As the Reserve Bank tries to lower inflation, it’s trying to preserve as many jobs as possible in order to keep the economy on an “even keel”. It’s deadly serious about maintaining the welfare of all Australians. But it’s also deadly serious about anchoring inflation and it won’t stop until that’s achieved. Loading…