The RBA is split over the inflationary effects of the latest rate hike. For Australians, it’s a bitter pill

Financial markets and economists were of one mind that the Reserve Bank of Australia (RBA) would this week announce yet another rate hike, its fifth in this cycle, and they did. But it’s probably worth focusing on the fact that three of the nine monetary board members voted to keep rates on hold.

To be clear, it’s likely the dissenters agreed that inflation remains too high at present: it clearly is. Underlying inflation, the best indicator of price pressures, has been outside the RBA’s target band (of 2% to 3%) for almost all of the past four years. The dissenters may well have been equally uncomfortable with the increase in inflationary expectations, which jumped up to 5.3% in October.

When people expect inflation to be higher, it can allow businesses to more easily pass on price increases – a vicious cycle.

Rather, as the governor made clear in her press conference after the decision was announced, the three mavericks felt that the downside risks to the economy from previous rate rises (and likely many other factors) were already large and that yet another increase would risk leaving the Australian economy too weak. The RBA disagrees and thinks the upside risks to inflation are the main game.

The press conference showed little nuance, or even respect, for those downside risks.

Economics is always about tradeoffs. Since the pandemic, the RBA has tried to stay on its “narrow path”, balancing growth (and employment) goals against inflation targets.

With both inflation and unemployment rising, it’s hard to say they are achieving either goal – but hindsight is a wonderful thing. So now our central bankers are telling us there’s to be no more mollycoddling: we will take our medicine until we recover, and it’s bitter medicine indeed.

The RBA’s latest forecasts in the accompanying November statement on monetary policy make for some grim reading. Overall economic growth is now expected to slow from 1.6% this financial year to just 1.3% over 2027-28. That implies that growth in per capita GDP (our individual slice of the collective economic pie) will, at best, be flat. Meanwhile, the overall pie only increases as a result of population growth.

Along with the slower growth outlook comes higher unemployment, which is expected to hit 5.1% by 2028. This seems to be a rather rosy outlook in my view. Real wages will fall further than previously forecast, as will productivity.

Across the economy, the numbers look a lot weaker, with two notable exceptions.

The first is, not unexpectedly, public sector demand, which has been left broadly unchanged. No doubt the federal treasurer will continue to face calls to find ways to cut spending (the states are conveniently being overlooked).

As an aside, notice it’s automatically assumed that if it’s public sector, it must be “bad” spending, but if it’s private sector, it must be “good.” All that wasteful spending on education, health, our older and less able citizens, not to mention transport. Business investment, on the other hand, gets a free pass, totally unexamined.

Business investment is the second area of the forecasts that has been, quite strongly, upgraded – largely the result of datacentre buildouts. In terms of the economy (as measured by GDP), the datacentres don’t make much of a difference – the imports required to build them count as a negative in our economic accounting system.

But datacentres do matter for inflation; the RBA governor even flagged this in her post-meeting conference. The current mantra of proceed at speed on datacentre rollouts comes at a huge cost. Just as the mining boom in the 2000s saw kids ditching education for large wages in the resources sector, this decade, our construction workers and tradies – even apprentices – are being enticed to work on datacentres at salaries of multiple what they would get in the residential sector.

This not only fuels demand from those workers getting well-above-average wage rises, but also creates a problem in housing and general construction, adding to price and wages pressures in a sector already under strain as infrastructure projects also compete for resources. And it crowds out investment in areas that might actually support productivity growth.

No doubt, the political classes and their advisers will be pulling their hair out for a solution to this problem and wondering what to do. Cutting government spending in any significant way at this stage could now actually tip us into a recession, given there are regularly wide margins of error in RBA forecasts.

There are rarely quick fixes to an economy that’s off kilter. It might be relatively easy (if costly) to give a kickstart when things are slow; it’s pretty difficult to rein back the spend quickly. Long-term budget sustainability is a necessary goal, but it’s not going to solve this year’s inflation problem.

Still, a temporary pause in the rollout of datacentres, which are of dubious benefit to Australia anyway, could be a good first step to removing one source of inflationary pressure.