MNI INTERVIEW: Further RBA Cuts Risk Policy Mistake - McKibbin

The Reserve Bank of Australia looks set to cut the cash rate by 25 basis points to 3.6% on Aug 12, but further easing could prove a policy mistake and force the Bank to reverse course within six months unless a major global shock intervenes, former RBA board member Warwick McKibbin told MNI.

McKibbin, who served as a board member from 2001 through 2011, warned that the RBA risks repeating its pandemic-era mistake of keeping rates too low despite accelerating nominal GDP growth. 

“The last three quarterly nominal GDP prints have been rising, with the latest at 1.4%. The nominal economy is already moving and we know it’s not real growth – there’s no productivity growth. There’s some labour supply growth, but real GDP is flat or growing very slowly,” he said.

Data over the next six months are likely to justify rate hikes if, in line with market pricing, the RBA cuts twice more and the global economy remains stable, he warned, advising policymakers to maintain an unchanged course. “I’d still be sitting on interest rates where they are [now],” McKibbin said. “I wouldn’t be raising them, as that would send the wrong signal to markets.”

The RBA surprised markets in July by holding the cash rate steady, despite Governor Michele Bullock strongly signalling further easing ahead. (See MNI RBA WATCH: Board Shocks With Hold As Trade Fears Ease) Markets are pricing at least two more 25bp cuts this year and a 3% cash rate by Q1 2026.

FISCAL PRESSURE

McKibbin said robust federal and state government spending was propping up growth amid weak productivity and would likely fuel further inflationary pressure. He also cautioned against overreliance on the CPI as a policy guide due to distortions from federal energy subsidies.

“You’re better off looking at what’s happening in the nominal economy – that’s driven by the real economy and the underlying inflation rate generally,” he said. 

Some economists may also be misreading weak growth as demand-driven, he added. “But actually, the economy is not growing quickly because the supply side is so weak. If you push extra demand into an economy without a supply response, you’re going to get inflation,” he maintained.

While the RBA may feel comfortable cutting next week, inflation will re-emerge unless productivity growth improves, he stressed. “Because that’s the magic bullet – higher productivity growth gives you higher economic growth and lower inflation,” he added.

NEUTRAL MODELS

McKibbin, now an economics professor at the Australian National University, estimated the neutral cash rate somewhere above 4%, much higher than market assumptions of around 3%. 

“Low productivity growth combined with significant population increases means the real interest rate is probably around 2%,” he said. Adding a time preference rate and inflation at 2.5% suggests a neutral rate in the region of 4.5%, he argued.

“That’s an equilibrium calculation,” he said, noting that nominal GDP growth of 1.4% a quarter also implied a similar level. “The nominal growth of the economy is accelerating – to me, that’s a sign monetary policy is too loose. If the nominal growth rate is over 5%, there’s no way the interest rate should be 3.5%, otherwise you’ve got excessively loose monetary policy.”

Lower neutral rate estimates from market economists are likely to reflect expectations that interest rates will revert to the low levels seen post-2008, he said. “Which is nonsense, because that was a very unusual period.”

McKibbin also criticised the RBA’s recent efforts to estimate the neutral cash rate using a range of models, saying they attempt to infer something that is inherently unobservable.

The models also ignore the strong correlation between Australia’s neutral rate and the U.S. federal funds rate, he added, citing research by Sydney University’s James Morley and Ben Wong. (See MNI INTERVIEW: Dollar Flight Risks Global R* Shift) “The current nominal interest rate in the U.S. is in the low 4% range,” he said. “Australia would need a very unique set of circumstances to sustain a neutral rate significantly below that.”