Why the bout between the Reserve Bank and the federal government is about to heat up

There's an old adage that oppositions don't win elections, governments lose them.

And if there's a lesson from Donald Trump's victory last month in the US, it is that the voting public appears more willing to mete out revenge than listen to political rhetoric or even economic reality.

Trump made a meal out of the cost-of-living crisis that has gripped America and the world.

It was all down to Joe Biden, he claimed. It wasn't, but that didn't matter to voters. And nor did all the glowing statistics about low unemployment, solid economic growth, decelerating inflation and even some serious interest rate cuts.

For nothing could soothe the pain from a gaping wound torn through middle America from decades of economic rationalism. The inflation outbreak two years ago was the last straw.

With an election due here in the first half of next year, the Albanese government similarly has begun to ramp up its achievements. Unemployment remains well below historic levels and inflation is rapidly coming down, a combination that is rarely achieved.

But there's no escaping the severe financial stress a huge number of Australian households are experiencing. The tide may have begun to turn, with real wages now on the rise, but that could take years to provide meaningful financial relief.

And that doesn't bode well for the government just months out from an election.

The one thing that could tip the scales is an interest rate cut or two. That, however, is an idea that has become increasingly elusive as the Reserve Bank digs its heels in despite what would appear to be ample evidence that at least some loosening is required.

Behind closed doors, there is a growing unease within government circles about the situation.

Having been lambasted for his outburst in September that interest rates are "smashing the economy", Treasurer Jim Chalmers most likely will steer well clear of any comment that hints of displeasure with the RBA.

But the longer governor Michele Bullock holds out, the higher tensions will run.

Why we're in a world of pain

In the past fortnight, quite a few commentators have belatedly discovered something odd about the Australian economy.

Living standards here have fallen much harder than almost anywhere in the developed world as this chart, measuring household disposable income, starkly illustrates.

Not surprisingly, it's created ammunition for headline writers and the opposition accusing the Albanese government of presiding over the greatest decline in living standards in more than half a century.

While the claim is absolutely correct, the reason has little to do with the government and almost everything to do with interest rates.

The obvious reason for the sudden drop in living standards was the 13 consecutives rate hikes — some of them double rises — pushed through by the RBA up until November last year.

That, however, occurred across the developed world, where rates were pushed even higher.

What makes us the Robinson Crusoe of the developed world is a quirk in our banking system and the way we lend money to households, as we've previously explained here and here.

In most other countries, and particularly America, home owners have their mortgages set for the life of the loan. So, interest rate rises only affect those about to borrow. They don't affect the vast number of households who already have a mortgage.

Here, most of our loans are variable rate loans and even our fixed-rate loans are for relatively short periods of five years or less.

That makes Australia far more sensitive to interest rate movements than almost everywhere else.

When interest rates rise here, households rein in their spending almost immediately as extra cash is diverted to mortgage repayments.

Not that voters care about who or what is to blame. All they know is that they are hurting and will register their protest at the first opportunity.

Everything except interest rates pointing lower

For more than two years, we've been in a household recession. The economy technically may have been expanding but only because our population has been growing, mainly through immigration.

Strip that out and we've been going backwards.

This week, our economic scorecard will be delivered for the September quarter and again, all bets are that growth will be weak, failing to keep pace with the number of new arrivals.

Inflation, meanwhile, has been steadily in decline, although that depends on which number you look at. The government is touting the headline number which has dropped to 2.1 per cent, right at the bottom of the RBA's preferred range.

The RBA, however, is ignoring the headline and concentrating on what's known as the "trimmed mean" which in October blew out to 3.5 per cent.

The divergence in the measures are in some ways a metaphor for the growing distance between the government and the central bank as the RBA ignores the impact of government subsidies on rent and energy bills.

Unlike in previous years, the December RBA meeting has been put back to the second week of the month so the board can evaluate the latest economic growth data.

All the signals emanating from the bank's Martin Place headquarters in recent weeks have been for an extended period of rates on hold with an outside possibility of a hike.

That's seen bank economists push rate cuts back from December to February and now to May, leaving precious little time for the government to spruik its economic performance in the lead-up to the election.

Housing has become a lightning rod for the community. Never has it been so unaffordable.

A lethal combination of record immigration and population growth and subdued construction has kept real estate prices at record levels and pushed rents into extreme territory.

Pressure, however, is starting to abate. Prices in Sydney and Melbourne are easing, allowing rental growth, once the key driver of inflation, to slide back to a more manageable 5 per cent.

But it is still horrendously expensive and likely to remain so for the foreseeable future.

Looking back in anger

Central banks are supposed to be ahead of the curve.

They apply fuel when it appears rocky times are ahead and touch the brakes when things look to be overheating.

If they do the job correctly, they should read the signals and make adjustments accordingly to avoid having to over-react after the horse has bolted.

At the November meeting, the RBA indicated it would be more forward-looking rather than merely relying on data from months ago.

But at the same time, Bullock has repeatedly reiterated that the RBA will not lower rates until it is convinced that inflation can remain sustainably within the target band of 2 to 3 per cent.

That's a pretty clear message that it will still rely heavily on old data, that it will remain backward-looking.

Inflation has fallen from 7.8 per cent down to 2.1 per cent, with rates stuck at 4.35 per cent for a year, indicating that the rate hikes have done their job and the economy is cooling,

Growth is, at best, sluggish, property is stagnating and households are struggling under the most severe downturn in living standards in generations.

The stand-off between the bank and the treasurer looks set to continue after next week's meeting.

That will coincide with Chalmers's next task; appointing independent directors to the RBA's new rate setting board in the new year.