Australia will only cut rates in late 2025, says ex-RBA official Jonathan Kearns

Australia’s interest-rate settings are “a bit too low” to rapidly stamp out inflation and as a result, policy easing is only likely to begin in the second half of 2025, according to former senior Reserve Bank official Jonathan Kearns.

When the central bank does start cutting, it will likely only do so twice in six months because it didn’t go “much above the neutral rate in the first place”, said Mr Kearns, who left the RBA last year after almost three decades to become chief economist at money manager Challenger. He was head of domestic markets and financial stability division before his departure.

Australia’s neutral rate — when policy is neither contractionary nor expansionary - is around 3.5 per cent, according to Mr Kearns’ estimate. The cash rate is currently at a 12-year high of 4.35 per cent.

Mr Kearns’s views, which come after the RBA stood pat for a fourth-straight meeting this week, are at the hawkish end of the spectrum. Another RBA alumnus, Luci Ellis, who’s now chief economist at Westpac, also anticipates a higher-for-longer scenario but expects a rate cut to be more likely late this year, like many analysts.

The consensus is for the cash rate to ease to 3.6 per cent by September 2025.

“When it comes to domestic price pressures, there’s not a lot of disinflationary impetus,” Mr Kearns said, highlighting that since mid-2023 the readings for non-tradeable, or domestic inflation, have barely budged.

Governor Michele Bullock on Tuesday defended the decision to keep rates unchanged and not toughen the language around the potential for another hike.

She insisted that current settings are “restrictive” and there’s unlikely to be a need for further tightening, even as she said that the RBA needs “to be vigilant about the continued risk of high inflation”.

That followed stronger-than-forecast price growth of 3.6 per cent for the first three months of 2024 compared with the central bank’s 2 to 3 per cent target, prompting the RBA to upgrade its inflation outlook in its quarterly economic forecasts.

That also drew scrutiny from Mr Kearns as such a move was typically associated with a rate rise.

“The RBA didn’t hike this week even after upgrading their forecasts which tells me that they are on hold for a long time to come and that a rate cut is unlikely before the second half of next year,” he said.

Westpac’s Ms Ellis, who oversaw economic forecasting for RBA and was the chief economic adviser to the former governor until her departure in July, didn’t rule out further tightening.

“While a rate rise does remain on the table, the more likely outcome is that rates are on hold until late this year or beyond,” she said.

Mr Kearns said the RBA faces credibility issues after a series of forecasting errors since inflation spiked in 2021 as the pandemic abated. Its forecasts in February 2021, for example, showed price gains would cool from an expected 3 per cent in June to 1.5 per cent by the end of 2022. Instead, the gauge ended up peaking at 7.8 per cent then.

Indeed, inflation overshot the RBA’s forecasts for most of 2021 and 2022.

Of the 14 largest forecasting errors over an 18-month horizon, 10 have occurred since 2021, he said. By the time inflation returns to around target — currently expected in late-2025 — cumulative inflation will be 14 per cent greater than was expected back in early 2021, Mr Kearns said.

Policy risks from inflation exceeding projections are much greater than those from it being lower than anticipated, he added.

“That large variance in inflation risks undermining confidence in the RBA’s inflation target, making its job more difficult,” Mr Kearns said.

Bloomberg