Australia has been warned that further aggressive interest rate increases may be needed to contain inflation, potentially leading to negative implications for the economy more generally.
In its latest Economic Outlook, the Organisation for Economic Cooperation and Development says it expects the Reserve Bank of Australia’s cash rate to reach 2.5 per cent by the end of 2023.
The RBA has so far raised the cash rate by 75 basis points at its past two monthly meetings to 0.85 per cent from the record low 0.1 per cent set during the depths of the COVID-19 pandemic,
But the OECD report, finalised prior to the RBA lifting the cash rate by 50 basis points this week, said strong global inflationary pressures and a tight labour market pose further upside risk to inflation in Australia.
“(This) could lead the Reserve Bank of Australia to tighten monetary policy more aggressively, with potential negative implications for consumption, investment and economic growth more generally,” the OECD said.
It believes while skilled migration will rise following the reopening of international borders, it is not expected to be sufficient to materially alleviate the tightness in the labour market.
The inflation rate spiked to 5.1 per cent in the March quarter, the highest level in more than two decades, and the OECD expects it will still be 4.1 per cent in 2023 – well beyond the central bank’s two to three per cent target.
The new Labor government has promised a cost-of-living package in its first first budget in October, after the former government’s support measures – such as the halving of fuel excise, which ends on September 28 – expire.
“Any further cost of living support needed beyond this date should be better targeted to low income households and delivered in a way that does not distort price signals,” the OECD said.
It expects the economy to grow by 4.2 per cent in 2022, a fraction faster than the 4.1 per cent predicted in December, but sees growth of 2.5 per cent in 2023 rather than three per cent.
The OECD said while the direct impact of the war in Ukraine on the Australian economy has been limited, it has – along with stringent COVID-19 lockdowns in China – exacerbated the supply-chain issues.
“However, higher commodity prices have boosted Australia’s terms of trade, and strong global demand for grains will support exports following the war-related disruptions to output in Ukraine,” it said.
It said the federal budget also received large revenue windfalls due to a stronger than anticipated economic recovery and high commodity prices.
It also said that given the risks to energy security, which have been highlighted by the Ukrainian war, the transition towards renewable energy generation should be further encouraged.
This should be accompanied with further investments in the transmission network.
The Paris-based institution again called for the government to undertake tax reform to reduce Australia’s heavy reliance on taxation of personal incomes, which adds to the vulnerability of public finances in an ageing population.
OECD’S LATEST KEY ECONOMIC FORECASTS FOR AUSTRALIA
(versus December forecasts)
2022 – 4.2 per cent (4.1 per cent)
2023 – 2.5 per cent (3.0 per cent)
2022 – 5.2 per cent (2.7 per cent)
2023 – 4.1 per cent (2.1 per cent)
2022 – 4.4 per cent (2.4 per cent)
2023 – 4.0 per cent (2.1 per cent)
2022 – 4.1 per cent (4.7 per cent)
2023 – 4.0 per cent (4.3 per cent)