Higher Rates, Harder Choices: World Adapts to New Economic Reality

The world is adjusting to a new economic reality marked by structurally higher inflation and rising neutral interest rates, according to CommBank's analysis.

This shift has been driven by various factors, including ongoing wars in Ukraine and the Middle East, stubborn inflation, and an investment boom that has drawn in vast amounts of capital, materials, and skills. Global bond markets have become increasingly skittish, with longer-term borrowing costs rising around the world.

The Reserve Bank of Australia (RBA) is grappling with this new reality and its implications for monetary policy. Despite a cyclical downturn in the Australian economy, underlying inflation remains too high, prompting the RBA to keep interest rates higher than in the past.

Part of the reason for this is that firms have taken time to pass on higher input costs, which are only now showing up in inflation measures. Deeper structural factors are also at play, including a potential lift in inflation expectations due to global supply shocks and a structurally tighter labour market.