Economic exceptionalism is dead – and rate cuts died with it

Australians endured the pre-Christmas Bondi terrorist massacre of Jews, an unexploded pipe bomb thrown into a January 26 Invasion Day protest and the collapse of an effective federal political opposition.

Amid the social and political stress, they now face a year of falling living standards.

Our much vaunted economic exceptionalism has “banged up against the constraints of the supply-side”, as Reserve Bank deputy governor Andrew Hauser warned just a week into the New Year.

Next week’s predicted Reserve Bank interest rate U-turn is part of the bad news task of reining in public expectations that the political class has over-inflated.

For it turns out that economic exceptionalism requires either good luck or exceptional, rather than mediocre, policy settings.

Rates look headed up, not down as Jim Chalmers’ political forward guidance advised voters last year.

This week’s above-target 3.8 per cent annual inflation number validates technical estimates of Australia’s productivity drought and, in turn, official assessment s that the economy can’t grow much more than a mediocre 2 per cent each year without pushing consumer prices and business costs higher.

We are becoming a high cost and low growth economy due to an incentive-dulling tax system, Labor’s job market re-regulation, the care economy government spendathon, the disinformation that the clean energy transition would be cheap, planning and zoning restrictions on housing supply and the ever-mounting regulatory and compliance burden.

The resulting weaker national income growth will put more pressure on a federal budget that The Australian Financial Review’s John Kehoe confirms has been hit by a $57 billion deficit blowout that will leave it still in the red in the mid-2030s. It’s mostly due to out-of-control public spending that Anthony Albanese wants to extend through a universal childcare entitlement.

“The public finances have weakened,” the OECD says in noting Labor’s lack of credible fiscal rules for containing government outlays. Without significant tightening, budget deficits will widen, putting public debt “on a steep upward path”.

And wage gains will be limited, notwithstanding Labor’s pre-election conceit that they could be regulated higher while productivity remained flat. Already, the OECD puts Australia in the bottom quartile of OECD countries for real wage growth since before the pandemic.

Unlike when Lowe headed the Reserve Bank, Chalmers doesn’t have a central bank governor to blame for his forward misguidance or for his complaint that monetary policy may be “smashing the economy”. In picking Michelle Bullock to replace fall guy Lowe, the Treasurer insisted that Australia would now have “the world’s best and most effective central bank”. Exceptional!

But not calling reverse ferret on her rate cut cycle would expose the central bank Bullock joined 40 years ago out of university to a damaging loss of credibility by inviting higher inflation expectations to become entrenched. The Reserve Bank’s preferred “trimmed mean” inflation measure has run ahead of its 2 per cent to 3 per cent inflation target for all but one of the past 16 quarters.

Before last year’s May election, the Treasurer crowed that financial markets were pricing in four Reserve Bank cash rate cuts over 2025 amid the disruption of Donald Trump’s tariff war on the world.

Instead, the central bank reduced its cash rate just three times last year. And now the markets predict a cash rate increase on Tuesday’s first monetary policy board meeting of 2026 after this week’s nasty CPI validated the board’s pre-Christmas concerns that the inflation risks had “tilted to the upside”.

Rather than a four-cut 3.35 per cent, the cash rate appears headed back up to 3.85 per cent, with markets tipping more tightening after next week. Australian floating rate mortgage borrowers, among the world’s most indebted, may ask: “Where’s my rate cuts”?

Heading into last year’s budget, Chalmers’ praised Australia’s “exceptional” achievement of getting the 7.8 per cent post pandemic inflation rate seemingly headed into the middle of the Reserve Bank’s target without a hard landing for the economy and jobs.

This was “unique among comparable countries”, he said, “unprecedented in Australia, and defying the economic orthodoxy.”

But above-target inflation is now bubbling up again in Australia more than in the UK, Europe, Canada or the US, as called out by both the OECD and the International Monetary Fund.

The jobless rate remains at an exceptionally low 4.1 per cent. But, instead of throwing people out of work, weaker national income growth is being spread more widely through weaker wage and household income growth. That’s being enforced by the backstop of the Reserve Bank’s monetary policy U-turn and rising tax, compulsory super and mortgage repayments.

Our exceptionalism is skewing more negative: with a top quartile cost of living and with weaker productivity growth than in the US, Canada, Japan, Europe and even the UK.

Australia’s early 21st century exceptionalism came with world-leading affluence. But this bubble of national prosperity peaked more than a decade ago and will deflate further this year.