IMF backs RBA's higher interest rate stance, warns of fiscal spending risk

It indicated that the permanent stage 3 tax cuts increase disposable income “remains too early to assess the extent to which they will be saved or spent” and therefore the effect on demand and inflation. State and territory governments were also mentioned for having more expansionary budgets than expected in the near-term.

The researchers further warned that disinflation may stall as services inflation remains sticky, should there be a "stronger-than-expected fiscal impulse" or if global trade and supply disruptions have significant effects. This could lead to higher for longer rates.

And they encouraged the government to put everything on the table to tackle housing affordability, citing the need for a "holistic policy package" that increases the supply of construction workers, relaxes planning restrictions, supports built-to-rent, reviews stamp duty, expands public housing and reevaluates property taxes "including tax concessions to property investors".

The government has maintained that it is helping, not hindering, the fight against inflation with its spending. However, its policies are under growing scrutiny as inflation continues to remain above the 2% to 3% target level on an underlying basis. The impact of stage 3 tax cuts and cost of living assistance has been hotly debated, with recent retail data indicating a bump up in spending in August reigniting discussions about the reasons for the lift in activity. At the same time, the RBA is being encouraged in some quarters to cut rates with the Greens suggesting the government should intervene directly if the central bank keeps rates too high.

If disinflation does stall, all levels of government have been encouraged by the IMF to undertake expenditure rationalisation to help lower aggregate demand and to better target payments to support vulnerable households.

What they said: “The current restrictive monetary policy stance is essential to address risks of prolonged inflation. Fiscal policy should support disinflation as the economy continues to grapple with supply capacity constraints,” the IMF researchers said.

“Additionally, macroprudential policies should maintain a stringent stance to mitigate the risk of excessive vulnerabilities in household balance sheets, particularly in the context of rising house prices. Should disinflation stall, monetary policy may need to be further tightened, supported by tighter fiscal policy while nurturing growth, and preserving targeted support to vulnerable households amid rising living costs.

“In this context, the RBA’s decision to maintain its restrictive policy stance in the near-term is appropriate."

In the outlook and risks summary, the analysts noted that the balance is tilted to the downside amid large uncertainty.

“Upside risks to inflation include a slower than forecast rebalancing in labor market demand and supply, potential larger fiscal impulses, demand impact of recent house price increases, and higher tradable prices due to rising geoeconomic fragmentation,” they said.