Got a hot tip for tomorrow? Do you go for the favourite or the outside chance?
Flemington will come alive at 3pm AEDT when the steeds in race 7 hit the track to determine this year’s Melbourne Cup winner.
But the big day traditionally features another major event that attracts far more punters and a whole lot more cash. This year promises to be even bigger than usual.
Half an hour earlier, Reserve Bank governor Phil Lowe is set to deliver a decision on interest rates, with billions of dollars riding on the outcome.
Why Melbourne Cup day? Well, the RBA meets on the first Tuesday of every month, bar January, and until now, there have been just four of those months that immediately are preceded by an inflation result. November is one of them and it just so happens the Melbourne Cup is always run on the first Tuesday of that month.
After the fastest rate hikes in history — 2.5 percentage points since May — there were hopes the pace of price growth might have slowed. But it wasn’t to be. The numbers were much higher than anticipated no matter which way you looked at them.
Even the RBA’s preferred measure, which strips out a lot of one-off movements and volatile items, set a cracking pace.
As a result, the biggest bet in town right now is a toss-up between whether the RBA will return to its double rate hikes of last month or maintain the single 0.25 percentage points lift that it dialled down to earlier this month.
The problem with economists
For the past 50 years, the world has increasingly been run by economists. They infect, sorry affect, government and the decision-making process of almost everything from health to air safety and, most importantly, how to keep the economy on an even keel.
If that’s the case, why do they so often get it so wrong? Just think of the number of financial market crises and economic meltdowns we’ve had since the 1980s, including the global financial crisis of 2008, which originated in of, all places, the United States — the place where the economics profession rules.
The kerfuffle about tomorrow is an illuminating insight as to how things can go so askew.
Economics is an inexact science because it is a study of human behaviour. As we all know, human beings can be entirely unpredictable. That’s when they’re acting as individuals. Put millions of them together and just about anything that can go wrong, will.
The economics profession assumes that’s not the case, that everyone always acts rationally. So, we’re already off to a bad start when it comes to forecasting.
Many then reduce everything to mathematical models that plug in data about how we’re performing and what to do next. And that’s where things really get messed up. Depending on how the input data is collated and the number of ways it can be interpreted, the end result is every bit as reliable as a dartboard.
Last week’s inflation data came in much hotter than expected. Immediately, financial markets pushed borrowing rates higher on speculation of an official double hike tomorrow. A range of market economists joined the throng.
They’ve plugged in last week’s 7.3 per cent annual headline inflation along with the monthly jump and what’s known as the core inflation and, bingo, decided the RBA will have to move by 0.5 percentage points.
But it’s not quite that simple. For a start, there is a significant lag between rate rises and when they begin to filter through to economic activity. And then there is the sticky issue of our huge levels of household debt. Add in that our mortgages are mostly variable or only fixed for short terms, and Australia is far more sensitive to interest rate movements than almost any other developed country.
If you believe the bond markets, anyone on a $750,000 loan will be forking out an extra $1,920 a month once the rate-hiking cycle peaks next year. That’s about 57 per cent more than they were paying before the RBA went on the rampage in April, which would be more than enough to tank the economy.
At the other end of the spectrum is the Commonwealth Bank. It is now forecasting repayment increases to top out at $1,370, up around 40 per cent on April’s levels.
The other three big banks are sitting between those two extremes, with ANZ closer to the bond market forecast and NAB and Westpac closer to CBA.
No matter which way it goes, it won’t be pretty, especially for the vast number of new home buyers who plunged into the market last year.
The potential for mistakes from the RBA is high and rising. Like most central banks, it was caught napping when inflation hit and it’s been forced to go into rate-hike overdrive.
It is well aware of the dangers. Push too hard and, despite what everyone is saying about buffers, it could send large numbers of new homebuyers to the wall with a sudden drop in household spending, a rise in banking bad debts and a self-engineered recession.
That’s why it became one of the first central banks to dial back the rate-hike speed this month, with Canada following suit and the US also looking at slowing down the pace.
What will stop the rate hikes?
If there’s one guaranteed way to ensure interest rate rises are limited, or maybe even reversed, it is to push the economy into recession.
It does, however, come at an enormous cost: millions of people unemployed, large numbers of them broke, along with misery and social mayhem.
Having had their credibility shredded by insisting inflation wasn’t a problem and, in our case, that rates were unlikely to rise until 2024, central banks are collectively holding firm that they will do everything to kill inflation regardless of the consequences.
But cracks already are appearing. The UK economic meltdown, which prompted a rescue by the Bank of England and sparked a political crisis, was one. Japan’s central bank has had to step in to support the yen. Europe, meanwhile, is labouring under the weight of exorbitant energy costs but is raising rates despite the threat of recession.
And then there’s China. Its currency is under pressure, capital is fleeing, the property sector is in meltdown and its growth is faltering as continued COVID lockdowns disrupt activity. Unlike the rest of the world, it is cutting interest rates, which tells you everything you need to know about its performance.
Add to this precarious scenario the enormous levels of debt now coursing through the global system.
China, Japan and European countries like Italy, Spain and Greece have huge government debts. US corporate debts are elevated while countries like Australia have low government debt but massive household borrowings.
Half a century of rate cuts across the globe, courtesy of an economic theory called monetarism, cut government, corporate and household risk to almost nothing. So they created their own risks by borrowing more.
Unscrambling that mess won’t be easy. But the pace will need to slow if we want to avoid the risk of everything blowing up.
The safe bet tomorrow? Take a punt on 0.25 percentage points.