Why the RBA will NOT hike rates before 2024

Markets are today busily repricing the prospects for interest rate rises around the world. This is being driven by the vaccine-led post-COVID recovery, ongoing monetary and fiscal stimulus and rising supply-side inflation associated with bottlenecks and runaway demand for goods while services are suppressed by lack of mobility.

Yesterday TD Securities argued that the RBA is not immune to these trends and the market is right to fight it on its outlook for no interest rate rises before 2024.  Is it right?

First, let’s check in on Australian bond curves. The short-end of the curve is being sat upon by the 300 pound gorilla at Martin Place but the long end of the curve has steepened dramatically as better growth and inflation prospects are priced in:

Second, spreads to the US have been relatively muted, not moving materially since Australia’s better virus performance became apparent through 2020:

I would summarise this as RBA success. It is keeping the yield spread to the US from blowing out despite very high term of trade. This is weighing on the Australian dollar relative to the counter-factual.

One might see holding down the AUD in such circumstances as inflationary given we’re entering an asset price boom which will doubtless lift domestic demand, further fueled by the national income boom.

However, there are some important factors weighing against this conclusion, especially as the recovery expands.

Terms of trade booms in Australia are not what they used to be because the income used to permeate the economy via better budget outcomes and tax cuts, higher stocks and rising wages as miners invested. Now, it is only the second of those that matters terribly with deep deficits to repair and plenty of mine capacity.

We already saw this play out before COVID.

So, that leaves the rest of the economy fighting a higher Australian dollar than it can manage. This will be seen in harm to all kinds of tradable sectors but most importantly education and tourism which will struggle to rebound post-COVID, even before we consider any new blockades from China.

Any rise in inflation will therefore hang on domestic demand. It will be strong enough to generate some inflation. But, again, there are powerful mitigating factors which include huge fixed-asset overcapacity in all service sectors owing to work from home and crushed immigration.

This may repair itself somewhat with vaccines and increased mobility plus a resumption of population growth. But that, as it is currently configured, will also crush wages so is self-defeating for inflation.

The point is that the Australian inflation outlook is not very strong in absolute terms nor relative, and it will be highly dependent upon rising house prices as it is.

Returning to the point of this post, that leaves the RBA rather snookered in terms of achieving its freshly minted much more aggressive inflation goals. It won’t be in any rush to lift rates on that basis alone. But it also has macroprudential tools for house prices to work with these days so when the time does come those will be used first. And, given how central house prices will be to the recovery, the spillovers over to the wider economy may be considerably more potent than the last cycle.

I can see the RBA not hiking until 2024. Indeed, I see it easing more before them via a pivot to the long-end of the bond curve with even more QE.

Fight it if you dare!

David Llewellyn-Smith
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Comments

  1. The global players will keep stoking uncertainty and chaotic events in each other’s backyards as we move toward a multi-polar world. How can the US dollar hold when they print limitlessly whenever such an event impacts them negatively? Inflation will happen and Australia will get caught up as it always does. Historically it takes decades to lose a global reserve currency, things move a lot faster these days.

    • Jumping jack flash

      “How can the US dollar hold when they print limitlessly whenever such an event impacts them negatively?”
      This is the solution du jour. There is no such thing as negative impacts any more. Bury them all under unprecedented and monumental amounts of stimulus.

      “Inflation will happen and Australia will get caught up as it always does.”
      We can but hope.

  2. pfh007.comMEMBER

    “..Fight it if you dare!..”

    One would have to be crazy to fight the RBA. There could not be a more predictable, uninteresting and thoroughly captured Central Bank than our bunch of fossils up in Martin Place.

    Donald Horne nailed them back in 1960

    “..Australia is a lucky country run mainly by second rate people who share its luck. It lives on other people’s ideas, and, although its ordinary people are adaptable, most of its leaders (in all fields) so lack curiosity about the events that surround them that they are often taken by surprise…”

    But the real issue is not whether the RBA will do anything interesting or novel or in the national interest (which dear readers is not the same thing as the interests of the private banks) but whether they are taken by surprise.

    So what might be the surprises?

    A few come to mind.

    1. China deciding to give us a serious trade smack and put us back in to Trade deficit and CAD land. Thereby forcing us to once again borrow from the world rather than lend to the world as we are doing now.

    2. Foreign Central banks realising that the only way to really kill off private money in the form of crypto is to allow the general public access to Central Bank digital currency in the form of Central Bank deposit accounts. And in doing so end or severely limit the monopoly and resulting privileges of private banks and their publicly backed private money. China might very well set the pace in this area as it has no private banks of any substance to corrupt its policy makers.

    What is really disappointing is that there are so few Australians who seem actually interested in driving the RBA towards reform despite their excited agitations on a bunch of minor issues that do not really amount to much.

    The RBA may have sold out to the interests of private bankers but to most Australian in the finance / banking field it remains a sacred and vernerable cloister full of disinterested monks and pointy heads and completely beyond serious questioning.

    And NO – begging the RBA to engage in more QE and more TFF does not amount to radical reform. It is nothing more than demanding that the RBA do what it really wanted to do but felt a bit guilty about doing as it was so shamelessly not in the public interest to be driving up the assets of rich people and supplying the ‘credit worthy’ with cheap credit to buy more existing assets.

  3. Jumping jack flash

    “The point is that the Australian inflation outlook is not very strong in absolute terms nor relative, and it will be highly dependent upon rising house prices as it is.”

    History would indicate that house price inflation alone doesn’t really translate into wage inflation very well. We do need CPI to bridge the gap between spending debt and wages rising. If we don’t get enough CPI then I guarantee that wages aren’t going anywhere, and that would be exacerbated by a resumption of wage theft, and everyone seems to be champing at the bit for it to resume.

    We would find ourselves back in the same desperate, pitiful hole we were in around the end of 2019, with no actual solutions because everything that was attempted would be gummed up with debt and wage theft, and in that scenario I agree completely with:
    “I can see the RBA not hiking until 2024. Indeed, I see it easing more before them via a pivot to the long-end of the bond curve with even more QE.”

    And that would probably be performed half-arsed and not really fix anything except go some ways to hiding the decline.

      • Jumping jack flash

        Well it depends on a couple of things such as CPI rising, and our leaders holding off on resuming wage theft (related, of course).

        If they decide that wage theft is just too attractive so business owners can feel richer and superior by robbing many Peters to pay a few Pauls, then we will be back to the same predicament as the end of 2019 – businesses failing everywhere, and stagnant and falling demand (because the debt simply isn’t growing fast enough if at all, because stolen wages simply can’t cut it), before you can say “whatever happened to the COVID stimulus?”.

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