‘Thumb on the scale’: Ex-RBA insider exposes rate hike flaw

Westpac chief economist Luci Ellis was formerly RBA assistant governor (economic), effectively the central bank’s chief economist. Picture: NCA NewsWIRE, Monique Harmer

A former Reserve Bank insider turned big four bank chief economist has exposed a critical flaw in RBA’s ‘one-sided’ internal models that could be artificially forcing mortgage rates higher.

Westpac Group chief economist Dr Luci Ellis – who previously served as the RBA’s assistant governor – warned top officials are relying on three overly gloomy assumptions that put a “thumb on the scale” tilting towards increased rates.

Aussie homeowners with mortgages are facing their next rate hike Tuesday. Picture: Brendan Radke

Dr Ellis said the RBA’s models relied on overly pessimistic assumptions – assuming worker productivity stays stuck at a 20-year low of 0.7 per cent, assuming workforce participation will flatten despite record highs, and assuming unemployment must stay higher to curb prices.

“Together, the three RBA assumptions imply weaker growth in supply capacity and thus more inflationary pressure for any given level of demand,” Dr Ellis said.

“If every one of your assumptions seems individually plausible, but all skew in the one direction, it starts to look like a pattern. The thumb on the scale is unlikely to be intentional, but it does suggest the likely direction of future surprises in the medium term.”

She said it was understandable for an inflation-targeting central bank to err on the side of caution, but warned of the fallout.

“They know that being downbeat, and running policy a little too tight, means a faster return of inflation to target, which is no bad thing for an inflation-targeting central bank,” Dr Ellis said.

“It matters, though, when those understandable assumptions are systematically one-sided.”

File image from the pandemic era of former Reserve Bank governor Philip Lowe (R) with Dr Ellis as RBA assistant governor fronting up to the House of Representatives Economics Committee at Parliament House. Picture: Tracey Nearmy/Getty Images.

She said “the RBA’s more downbeat set of assumptions could be unwittingly contributing to a self-fulfilling talking-down of Australia’s prospects.”

Dr Ellis flagged a gap between the RBA and Federal Treasury, which showed the central bank taking a far darker view of Australia’s potential than its government.

“In one corner, Treasury assumes that future productivity growth will average 1.2 per cent a year over the next 40 years … In the other corner, the RBA assumes that productivity growth will average 0.7 per cent a year,” Dr Ellis said.

The RBA’s gloomy model assumed modern technological advances like AI would have zero impact on worker output, when “the AI boom and associated resurgence of risk appetite make it hard to argue that we will see the same lack of new productivity-enhancing technologies” she said.

“To assume 0.7 per cent productivity growth requires a repeat of past drags despite massive domestic and global investment.”

All four big banks expect the Reserve Bank to hike Tuesday but are torn on what happens after that. Source: Canstar

The revelation comes as the RBA board meets Tuesday to decide whether to lift the official cash rate by 25 basis points to 4.6 per cent – a move that would push interest rates to their highest level in over a decade.

New Finder analysis said a rate hike on Tuesday would add another $122 a month to an average $736,259 Australian home loan.

Canstar’s database shows 18 lenders have already quietly jacking up home loan rates this month, with Westpac doubling its national property forecast to a 7.3 per cent drop this year.