Business Outlook: can central banks thread the needle?

A lot has changed in the last few months, and as a result, Deloitte Access Economics’ latest Business Outlook has downgraded forecasts for the macroeconomic outlook – economic growth is now expected to be slower, with inflation and interest rates now higher.

The global and domestic economic outlook is clouded by uncertainty and volatility. Higher inflation, rising interest rates, falling house prices and weakening consumer confidence are testing the resilience of the COVID recovery, just as a resurgent virus reminds us that it can’t be ignored.

Global economic conditions are softening, but widespread alarm is unhelpful particularly when some of the global drivers of inflation are already starting to subside. That includes a decline in the oil price, as well as continuing falls in the New York Federal Reserve’s global supply chain pressure index, which in June fell to its lowest level in more than 12 months. There is still a long way to go before global supply chains return to normal, but some unclogging of bottlenecks is a positive for the inflation outlook.

On the home front, the RBA has moved sharply in response to the high inflation result in the March quarter. Peak price growth in Australia is coming later in 2022, but that isn’t a certainty. Price growth – measured by the headline Consumer Price Index – is expected to peak at 6.6% in the second half of 2022, while interest rates set by the RBA may peak below 2.5% in the current cycle, well below current market expectations.

Setting interest rates in the current environment is more than a little tricky. Rising inflation is one thing, but it is also clear that growth is slowing. The post-pandemic high is fading quickly as house prices begin to turn downward and consumer confidence continues to slip. Add in the darkening global outlook and it becomes quickly apparent that the risk of raising interest rates too much needs to be balanced against the risk of not raising them enough. It’s the job of central bankers to thread that particular needle right now, and the degree of difficulty could not be higher.

Chart 1: Underlying inflation and the real short term interest rate 

Source: Deloitte Access Economics; Australian Bureau of Statistics; Reserve Bank of Australia

Wage growth is also expected to trend higher more quickly than previously expected, though real wages will still be going backwards in the near term. Wage growth with a three in front of it is very reasonable, and any potential for wages to chase prices higher will ultimately be detrimental to workers in the long run.