The Reserve Bank of Australia has sent its strongest signal yet that the emergency measures it introduced to support the economy during the Covid pandemic will now be wound back, paving the way for an earlier than expected interest rate rise.
As expected the central bank left the official cash rate target at the record low 0.1% annual rate set at the November board meeting last year. Analysts’ attention, though, was focused on the shift in the language of its accompanying commentary.
Previous months’ statements had identified 2024 as its “central scenario” when inflation would be “sustainably” within its 2%-3% target range.
A recent pickup in core inflation to 2.1% in the September quarter – entering that target range for the first time in six years – and other recent signs of a recovery in the economy since the lifting of Delta Covid-19 lockdowns in NSW, Victoria and the ACT has given the RBA confidence to bring that date forward to 2023.
In order for the actual inflation rate to remain within 2%-3%, the labour market will need to be “tight enough to generate wages growth that is materially higher than it is currently”, Reserve Bank governor Philip Lowe said, adding “this is likely to take some time”.
“The board is prepared to be patient, with the central forecast being for underlying inflation to be no higher than 2.5% at the end of 2023 and for only a gradual increase in wages growth,” he said.
The country’s central bank declared “a bounce back is now under way” after the Delta outbreak, with companies now hiring and the job rate set to trend lower for the next couple of years.
The RBA expects GDP growth of 3% over 2021, and 5.5% and 2.5% over the following two years, it said. “One important source of uncertainty continues to be the possibility of a further setback on the health front.”
The encouraging comments about the economy will likely mean interest rates rise sooner than that 2024 scenario previously stated by the bank.
While the cash rate was left unchanged for now, the RBA has surrendered to market forces and ceased trying to keep the yield on the benchmark April 2024 to just 10 basis points, or 0.1%. However, the bank also maintained its bond buying at the $4bn a week pace until at least mid-February 2022.
“The decision to discontinue the yield target reflects the improvement in the economy and the earlier-than-expected progress towards the inflation target,” Lowe said. “Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished.”
The Australian dollar dropped below the US75 cent mark, bond yields fell, and the stockmarket rose after the RBA statement. Economists including AMP’s Shane Oliver continue to expect the first rise in official interest rates to come by the end of 2022.
#RBA keeps cash rate at 0.1% but drops 0.1% yield target reflecting better econ, higher inf & it being less effective. Also dropped reference to timing of rate hikes being "not before 2024" to now the conditions "will take some time". RBA forecasts suggest maybe late 2023. pic.twitter.com/8PUznQTZRk
— Shane Oliver (@ShaneOliverAMP) November 2, 2021
Maxime Darmet, a director at Fitch Ratings, said “it’s really like the first step we think towards the normalisation of [Australia’s] monetary policy settings, which had been very loose since the pandemic”.
However, he said should the recovery remain strong we can expect more adjustments sooner than the 2023 RBA forecast: “It’s very possible that in the next meeting they would think it would be 2022.”
Evidence the RBA can start paring back emergency measures will be noted elsewhere, with the central banks of the US and the UK also holding key meetings this week.
The US Federal Open Market Committee begins two days of meetings today and investors are expecting it to announce a reduction – or tapering – of its quantitative easing problem on Wednesday. Since March 2020 as the first Covid waves disrupted the world economy, the Fed has been buying up $US120b in bonds and mortgages each month to drive down interest rates and support the economy.
On Thursday, the Bank of England announces its policy decision, with investors wary that it will lift interest rates to quell rising inflation in the UK.
In Australia’s case, the RBA has already eased its bond-buying binge from $5bn a week to $4bn in its bid to keep commercial banks flush with cheap money that they can lend.
Much of the borrowing activity, though, has ended up in residential housing. October house prices were almost 22% higher than a year ago, CoreLogic said on Monday.
Separate figures from the Australian Bureau of Statistics, also out yesterday, revealed a small drop in housing lending for owner-occupied housing in September but the tally was 49% higher than pre-Covid levels in February 2020.
Fitch’s Darmet said the RBA had been relatively “dovish” in its signalling that it was not worried about inflation. However, it also couldn’t be seen to be too slow in responding as central banks in the US, Canada and soon the UK prepare to wind back support for the economy.
“You’re seeing so much pressure on prices at a global level with energy prices spiking, with supply bottlenecks persisting and so on,” Darmet said. “It’s a very dovish central bank but starting gradually to come around to the new reality that inflation is going to be probably higher than they expected.”
While mortgage holders can take some relief from Tuesday’s RBA comments that an interest rate rise isn’t around the corner, Australia and other nations have allowed housing prices to rise too far too fast for the overall health of the economy, not to mention housing affordability for those not in the market.
“Low interest rates are the main channel through which people are taking on more debt,” Darmet said. “[It] can become a concern in terms of not only affordability for low income households, but also it creates a lot of potential financial instability and risk.
“And this is something many central banks are not taking too seriously,” the Fitch analyst said.
In an unusual webinar – used to explain “important announcements” – Lowe said Tuesday’s meeting had not discussed house prices “in any detail”.
“At the moment, I don’t have any concerns about the deterioration in lending standards” for home loans, Lowe said.
Instead, the focus was on the decision to end the yield curve target, which had made recent days “turbulent ones in the bond market”, he said.
The central bank chief also made it clear the RBA is not about to lift its cash target rate, dismissing market predictions of a rise as soon as next March “as a complete overreaction to the recent inflation data”.
A reason for caution is that the Covid pandemic might not have finished in terms of its ability to throw the economy off track.
“One source of such a shock would be a new strain of the virus or a decline in vaccine effectiveness,” Lowe said. “In this case, the cash rate would need to remain at its current level for longer than otherwise.”
While there are supply shortages of some goods, those could ease over the coming six months or so as consumers respond to the end of lockdowns by switching some of their spending to services.
While many overseas economies faced higher energy prices, Australia’s electricity prices at least are lower than a year ago, Lowe said, as was reported last month.
