International Monetary Fund backs in Reserve Bank’s call to hold fire on rate cuts

Treasurer Jim Chalmers and his State colleagues have been told they’ll need to slash spending if Australia can’t slow inflation in a report by the International Monetary Fund.

The top economic agency said federal tax cuts and cost of living support were likely to move the Budget into deficit and add to demand.

That’s just as the Reserve Bank is warning interest rates will need to stay up to slow spending and rein in inflation.

The IMF’s review took particular aim at a flood of poorly targeted handouts for households and rising infrastructure spending “aggravating” pressure in the construction industry.

“State and Territory budgets have proven more expansionary than expected in the near-term, incorporating further cost-of-living support and infrastructure spending,” the IMF’s staff said after an annual visit to Australia.

Getting spending under control “at all levels of government” would help lower demand and “support a faster return of inflation to target”.

It comes after a series of economists have warned State and Federal Government spending is near a record share of the economy and making price pressure worse.

Federal spending rocketed $45 billion in the most recent financial year to hit a fresh record high of $673bn.

But it wasn’t all bad news.

The financial agency said the Government’s second consecutive surplus was welcome.

“This was achieved by saving revenue windfalls from a resilient Labor market and higher commodity prices, and identifying expenditure reductions or reprioritizations while implementing cost-of-living relief measures,” the IMF said.

The IMF said inflation was slowing in Australia but was still elevated amid pressure in rents, insurance and other sectors.

Underlying inflation was expected to sustainably in the Reserve Bank’s 2 to 3 per cent target range by the end of 2025, the IMF’s preliminary statement said.

And growth is set to modestly recover next year, rising from 1.2 per cent to be 2.1 per cent in 2025.

The International Monetary Fund is backing the Reserve Bank’s cautious approach to easing Australia’s credit crunch, noting an “uncertain” global environment and “geoeconomic fragmentation” pose significant risks to an economy still struggling to tame sticky inflation.

In its latest report on the state of the nation’s financial health, the IMF said 13 rounds of interest rate hikes since May 2022 had worked to slow growth and pull inflation back from its 7.8 per cent peak in December 2022.

But it remains elevated as demand-supply imbalances linger, particularly in sectors like rents, new dwellings and insurance.

The IMF warned further tightening could be required — “while preserving targeted support to vulnerable households amid rising living costs” — if the RBA loses its grip on inflation.

“Near-term policies should continue to focus on reducing inflation while nurturing economic growth,” the report said.

“The Reserve Bank of Australia’s continued restrictive monetary policy stance aimed at combating persistent inflation is appropriate.”

RBA governor Michele Bullock faced increasing political pressure ahead of last week’s policy-setting meeting to cut rates and ease the pain felt by homeowners struggling to keep up with higher monthly mortgage repayments and sticky inflation that has kept some prices elevated.

But speaking after the board again held the official cash rate at 4.35 per cent, she doubled down on the central bank’s mission to pull the inflation rate back to within its preferred 2 to 3 per cent target range and again warned relief would likely not come until next year.

“We think we’re in the right spot at the moment,” Ms Bullock said.

“We need to focus . . . on what we think is best for the Australian economy. (Inflation) is the challenge for the Australian public. That’s why people are hurting.”

Australia’s big four banks are now tipping an interest rate cut by mid-February following the release of data by the Australian Bureau of Statistics last week that showed underlying inflation — the RBA preferred measure — had fallen one percentage point in the past three months to now be at 3.4 per cent. Headline inflation now sits at 2.7 per cent.

However, the central bank has warned lower inflation would need to be “sustainable” before it considers cutting rates.

The IMF said it was too early to tell if households had banked or spent stage three tax cuts that came into effect on July 1.

But it did sound a warning over State and Territory Budgets that “have proven more expansionary than expected in the near-term” as politicians win over voters with cost-of-living relief, such as power rebates.

The IMF is projecting a “modest” economic recovery in Australia next year, pushing growth from 1.2 per cent for 2024 to 2.1 per cent for 2025, fuelled by real income growth and a resilient labour market which remains low.

“Should disinflation stall, policies may need to be further tightened while preserving targeted support to vulnerable households amid rising living costs,” it said.

“Financial sector policies should prioritise preserving stability, while tackling localised vulnerabilities arising from tightened financial conditions.”

As households cry out for relief and grow increasingly frustrated at the prospect of higher-for-longer rates, the IMF also alerted the RBA to the way it communicates policy-setting decisions.

“While inflation expectations have remained anchored, the RBA should continue to build on its recent efforts and explore ways to further strengthen its communications capabilities and effectively guide the general public’s and the market’s understanding of its data dependent decision-making process and their expectations regarding policy shifts in an uncertain global policy environment,” it said.

It also noted Australia’s “significant” housing supply crisis, and said a “holistic approach” was needed to put in place workable solutions.

“To address these issues, a comprehensive strategy is essential, focusing on increasing construction worker supply, relaxing zoning and planning restrictions, supporting the built-to-rent sector, expanding public and affordable housing, and re-evaluating property taxes (including tax concessions to property investors) and stamp duty to promote efficient land use.,” it said.