- It was anticipated that the RBA would end its yield curve control policy at its November meeting;
- The RBA is open to a rate change in 2023, but thinks moves in 2022 unlikely;
- The timing of the first rate move will depend upon wages growth;
- The CPI numbers have not changed my view of the first cash rate move in H2 2023;
- The big issue for the equity market is the level of the cash rate peak.
Interest rate views have changed dramatically in just a few weeks. The reason is that financial markets are increasingly worried about inflation. Domestically, firms’ have become concerned about price pressures and consumers’ have started to feel the impact of those pressures.
As economies have re-opened demand has risen quicker than supply. Government restrictions and consumer confidence across the world have limited the ability of firms to crank up production. The result has been higher prices and supply bottlenecks. There are signs that these pressures are easing. Shipping prices have fallen and the price of many household appliances have declined in each of the past four quarters.
There are plenty of reasons to think that wages growth across the economy should increase. Employer hiring intentions and job vacancy data indicates a strong demand for workers. Workers are indicating they are not fearing unemployment. But wages growth is likely to take some time to reach the 3% mark that the RBA indicates would be consistent with its inflation target (and therefore to raise the cash rate). The underutilisation rate is currently a bit above its long-term average. The participation rate is below its historically high level it hit in the first half of 2021. And after an extended period of low outcome, worker expectations of wages growth remains low.
The RBA made three announcements followings its November Board meeting. The first was that they decided to maintain its $4b weekly pace of buying of federal and state government bond. An increasing number of analysts believe that the RBA may stop buying bonds altogether by May. But I think it might be later as the RBA may well be happy to lag behind other central banks (particularly the US).
The second decision was that the RBA would cease its yield curve control policy. It had become increasingly clear that stronger demand and supply problems would mean that the cash rate would most likely need to rise earlier than the RBA’s view of 2024. Other financial market interest rates (notably swap rates) had already risen and leading to higher borrowing cost (such as fixed rate mortgages).
The third announcement was that the cash rate would remain unchanged at 0.1%. Financial markets can see an interest rate rise on the horizon and expect the cash rate to be at least 0.75% by end-2022. That appears excessive given that inflation and wages growth in the US is higher than in Australia but financial markets are pricing bigger cash rate moves by the RBA.
The updated RBA forecasts are consistent with a rate move in 2023 (consistent with my view). The RBA has indicated that there are scenarios that could see the first cash rate rise occur in 2024. But they see very little probability that there will be any rate moves in 2022. I agree a first move in 2024 remains a possibility. But so is 2022 if wages growth ends up being above 3% and (underlying) inflation above 2%.
The bigger issue for equity markets is not when the first rate hike occurs but how many rate hikes will take place. As it currently stands financial markets have a peak cash rate in this cycle of 2-2.5%. If current financial market pricing is correct then interest rates will be negative after taking into account inflation (in the jargon, ‘real’ interest rates will be negative). The concern for equity markets is if real interest rates turn positive (ie, the expected top in the cash rate is higher than inflation).
To read my full update, click here.
We live in interesting times.
Peter Munckton - Chief Economist