Lunatic RBA to hike 50bps into global crash

Bill Evans of Westpac is serenely cheering on the Lunatic RBA. He needs to wake up. This is a rerun of the errors of early 2008 when a global recession and ginormous deflationary shock were hurtling toward Australia and the Lunatic RBA hiked its way to the moon chasing supply-side price rises it could not affect.  

The Reserve Bank Board meets next week on July 5.

We expect the Board will decide to lift the cash rate by 50 basis points from 0.85% to 1.35%.

We assess the neutral zone for the cash rate at 1.5-2.0%.

Consequently, even after that move the cash rate will still be below the “neutral zone” and in stimulatory territory.

Following the May Board meeting when the cash rate was raised by 0.25% the Governor’s subsequent press conference left listeners with a clear impression that the Board was likely to follow a path of “steady” 25 basis point movements.

While we acknowledged that signal from the press conference, we argued that the time was right to predict the “right policy” rather than follow the guidance.

The “right policy” was to make a larger move when rates were clearly in the stimulatory zone; inflation was well above the target zone; and the unemployment rate was at a 48 year low.

We argued for a 40 basis point increase at the July meeting, while acknowledging that a 50 point increase was fully justified by our arguments.

We advocated pushing hard on rates at the beginning of the cycle when the risk of overtightening was low. It was really important to send a decisive signal that the RBA was committed to returning inflation to within the target band in the medium term.

Consequently, we were encouraged by the decision at the June meeting to raise the cash rate by 50 basis points. Note that the last time there was a 50 basis point increase was in February 2000.

The Minutes of the June Board meeting describing the decision to move by 50 basis points supported our approach; “The main argument for an increase of 50 basis points was that the level of interest rates was still very low for an economy with a tight labour market and facing a period of higher inflation”.

The Minutes also pointed out that even after a 50 basis point move “the cash rate would be highly stimulatory”.

The policy of a 25 basis point increase was discussed at the June meeting.

“The argument for an increase of 25 basis points was that a sequence of 25 basis point moves represented a steady approach to withdrawing monetary policy stimulus and that this was appropriate in an uncertain environment”.

The impotence of a predictable, steady sequence of 25 basis point moves was demonstrated during the housing bubble period in the US. Between June 2004 and May 2006 Chairman Greenspan’s FOMC raised the federal funds rate at every meeting by 25 basis points. That steady , predictable policy did little to dissuade speculators about the FOMC’s commitment to maintaining stability.

My interpretation of the “uncertain environment” is that in due course, when rates are higher, that consideration will be relevant. Once policy is near the top of the “neutral zone” the impact of policy on the economy does become more uncertain and caution is warranted.

The other benefit of the 50 basis point move at the June meeting was seen to be “there is a heightened risk of persistently high inflation, especially if expectations of higher inflation become entrenched.”

That concern around inflationary expectations stands out as a key consideration not only for the RBA but also for all central banks.

A “steady” path of 25 basis points would certainly have much less “shock effect” on the assessment of the commitment of the RBA to containing inflationary pressures.

So, now that the Board has clarified its position on the best approach to policy it would seem quite clear that with the cash rate at only 0.85% a second decisive move of 50 basis points is the appropriate policy.

The Minutes noted the “evolving risks to household consumption” including the dampening effect of higher prices and interest rates on consumption and the impact of higher interest rates on house prices. But this concern was tempered by the accumulation of large financial buffers and a very high current household savings rate.

These observations, along with the current boost to spending from the reopening effect, all point to the Board having considerable confidence from the high frequency data that a second “large” rate increase will not significantly damage the economy in the near term.

From our perspective the issue becomes one of when it will be appropriate to scale back the rate hikes as uncertainty around the impact of higher rates becomes more real.

We do not think policy will reach that stage until after the Board meeting in August.

This meeting will follow the release of the June quarter Inflation Report. We expect annual underlying inflation (Trimmed Mean) will print 4.2% (up from 3.7%) with upside risks while annual headline inflation will print 5.9% up from 5.1% – with a likely trajectory towards 7% by year end.

Based on our forecast for the July meeting the August decision will still be in the context of rates being in the stimulatory zone (at 1.35%).

An outsize print for inflation with rates still in the stimulatory zone will make a further strong case for a third increase of 50 basis points.

The Governor’s Statement following next week’s Board meeting and the associated Minutes which will print on July 19 will provide some guidance as to whether the Board believes the cash rate is still stimulatory at 1.35%.

We think the need to contain those inflationary expectations in the face of another outsize inflation print and the assessment that policy is still stimulatory will indicate to the reader that the Board is open to a third 50 basis point move in August.

We would be very surprised if the Statement indicates a commitment to scale back the rate hikes to that “steady” 25 basis point process for the remainder of the year.

In fact, our view is that a better policy would be to raise the cash rate by 50 basis points in August and then pause in September so that the unprecedented cumulation of four consecutive meetings totalling 175 basis points can be assessed.

There will be no indication of that strategy in July. We will have to await the August Statement to see whether the pause is favoured by the Board.

Conclusion

The 50 basis point increase in the cash rate at the July 5 Board meeting seems highly likely.

We will be particularly interested in any guidance the Governor may provide about the August meeting, where we expect a third consecutive 50 basis point move prior to a pause in September.

The June quarter inflation data, to be published on Wednesday July 27, will be a key update a little less than a week prior to the August Board meeting.

Houses and Holes
Latest posts by Houses and Holes (see all)

Comments

  1. pfh007.comMEMBER

    Bill gets it right.

    “… The impotence of a predictable, steady sequence of 25 basis point moves was demonstrated during the housing bubble period in the US. Between June 2004 and May 2006 Chairman Greenspan’s FOMC raised the federal funds rate at every meeting by 25 basis points. That steady , predictable policy did little to dissuade speculators about the FOMC’s commitment to maintaining stability…”

    The point of raising interest rates is to reduce demand for money created by the private banks …also known as credit creation or debt peddling.

    Reducing money creation is a pretty sensible approach to resolving the problem of inflation where money loses value.

    And yes, if the pearl clutching hyperventilators…..”will no one think about the household debt hogs”….are right and small rate rises are enough then the RBA will stop reducing demand for bank credit.

    But given the history of bailing out property speculators down under it might take more rate rises then we think to change attitudes in punter land.

  2. Dave666MEMBER

    Did you see the explosion of job vacancies numbers this week? I recon there is a strong chance the RBA will go 0.75% next meeting.

    • pfh007.comMEMBER

      Yes, staff are watching the stats as well and the salary review requests are now arriving.

      Albo will need to send out charter flights to scoop up cheap labour from the developing world if he doesn’t want wages moving upwards with momentum. Hard to call a salary review bluff if no one is applying to your job ads!

      Either way the RBA is going to keeping cranking up rates until the inflationary expectations out in the burbs are thoroughly crunched.

      The fastest way to create a wages price spiral is to allow the debt peddlers to peddle cheap credit to folks who just got a pay rise.

      • Dave666MEMBER

        Nicely put.
        I wonder what’s going on with immigration? Be interesting to see the latest numbers. I wonder if immigrants now consider Australia too expensive?

        • MathiasMEMBER

          Im pretty sure they arent here because they are Loyal.

          Maybe the money ran out lol. Money does tend to run away pretty quickly when your having a Stockmarket / Property crash heh.

          Surfs up dude ;p

      • Jumping jack flash

        Nah, we’re just seeing the tail end of their attempt at hyperinflating the debt away. There will be a bit of a hangover as one policy fades away and the current one replaces it.

        The only reason most jobs and wages exist today is due to debt expansion and debt spending creating demand. The current boom – initially in inflation, and now appearing in spending and new jobs being created, is a direct result of their initial policy of hyperinflation that was recently scuttled.

        As debt becomes more expensive and stops expanding so quickly from the absurd, massive rises in interest rates, that demand will disappear, and along with it the jobs and wages it created.

      • ”The fastest way to create a wages price spiral is to allow the debt peddlers to peddle cheap credit to folks who just got a pay rise.”
        Really? Making credit more expensive wont put upward pressure on wage claims? I thought the spiral resulted when labour had enough bargaining power to ensure a greater share of returns as the labour market tightened. It’s a bit of a stretch to say that is the case here.
        Edit: I agree rates need to go up but, the RBA cant do all the lifting here because the causes of inflation aren’t easily addressed by interest rate rises.

        • pfh007.comMEMBER

          AlexD,

          I think you may have misunderstood what I wrote.

          I didn’t say anything about a relationship between interest rates and wage rises.

          Low unemployment is the best way of giving more power to workers to gain a larger share of profits.

          Whether that leads to inflation is the issue and whether it does depends on what happens in the credit creation space.

          Low unemployment is good.

          It does not have to lead to inflation.

          • I don’t think I have misunderstood.
            ”I didn’t say anything about a relationship between interest rates and wage rises.”
            You contended giving cheap credit to those with higher wages is the fastest way to create a wage price spiral. I am simply saying that contention only holds true when labour does actually have significantly more bargaining power (which it doesn’t) and if it did have that power, then labour will simply want bigger wage increases to cover the cost of higher mortgage rates.

            It’s true there are some shortages of labour in some sectors but, real wage figures suggest unemployment figures are a less reliable way of assessing bargaining strength (and therefor likely wage growth) than they were in the past. The fact we have seen real wages go backwards for much of the last ten years while unemployment has generally been low only strengthens my view re this.

            The RBA has a brief and only one lever it can use to achieve its inflation target. There’s little doubt it is time to increase rates but, there is also little doubt these rate rises are going to do little to stop the supply driven sources of inflation (which are significant). A severe recession is likely if the supply shocks continue and the central banks are left to do all the work.

  3. Jumping jack flash

    75bp sometime between now and the end of the year. Maybe a whole 1%.
    Completely depends on energy and food prices and the inexorable trudge towards the NH winter.

  4. They better hike the rates now so that they may have something to cut when the s**t hits the fan!

  5. Why doesn’t MB ever talk about the people that benefit from higher interest rates?

    • pfh007.comMEMBER

      I suspect the reason is that “higher interest rates” on unsecured investments (bank depsoits) in private banks are deeply unpopular with private bankers and most economists seem convinced by the idea that what is good for bankers is good for Australia.

      Allowing the public to operate 100% safe and secure reserve accounts at the RBA that pay no interest and which they can use to save without risk would mean that people who wish to invest some of their savings and accept some risk for some return would be making an explicit decision to do so.

      People might start make a clear distinction between saving and investment and start to see making an unsecured investment in a bank (which is what a bank deposit is) as a risky investment and will not do so unless they receive a decent return.

      Bankers would then be competing with every other non-bank investment manager or lender for investment funds and the bankers simply hate that idea.

      They love their current monopoly on reserve accounts at the RBA and all the customers that are forced to invest with them because they are denied the ability to save and operate a bank account at the RBA.

      When people are not interested in a participant (like a bank) in a market being forced to compete for investment funds and instead take the view that bankers should been given a massive advantage in attracting investors (operating a bank account is fundemental to day to day life) it is not suprising that they are not very interested in whether those forced investors are receiving an appropraite return on their investment.

      • great idea, except it doesn’t factor the behaviours of savers that got f**ked for 20+ years. Human sized, Norman rats permanently changed that system in the late 50’s. You or I cannot fix it, plus everybody still votes for Norman faced rats.

  6. Pfh007. If bank deposits are gurateed under the ADI to the tune of $250K, then arent these in effect Reserve Bank accounts as you so request in your second paragraph? People just need to make an effort to open more than one account if they have >$250K, and allow some leway for accrued interest in case a bank did go under. They will get thier money back? No risk accounts with Interest?

    • Except they are not guaranteed to 250k, I have read a couple of articles stating the deposits at each financial institution are only guaranteed up to 10 Billion, at the time I read the article CBA had deposits of over 960 Billion. Do the math!
      I think they call that “Smoke and Mirrors” its all about confidence.

      • pfh007.comMEMBER

        carey01,

        Yes – I would not want to “bank” on the protection of deposits that is currently in place. There is a reason why the government did not gurantee bank deposits before the GFC.

        When a bank goes bust why should the taxpayer bail-out unsecured investors?

        Why not just allow people, who want to keep some of their wealth liquid and safe, to operate a reserve account at the RBA.

        Beats lumps of gold under the lemon tree or bank notes wrapped in prawn heads in the freezer.

    • pfh007.comMEMBER

      ggdesu,

      That is what the banks would like you to believe but there is a world of difference between an unsecured investment in a bank that is given ‘some’ protection by way of a public guarantee (that is paid for by the private banks.who then deduct the cost of the guarantee from the interest they pay for your unsecured investment) and an actual reserve deposit in an RBA account operated by the public..

      Leaving aside the absurdity of forcing people into business relationships with banks, it is just a crazily artifical way of trying to do what could be done much more easily.by allowing the public to open and operate reserve accounts at the RBA.

      If you want to save without risk you open up a RBA reserve account and deposit money into that account.

      Job done. Savings are secure and liquid but you do not get paid any interest because the RBA does not make loans and there should not be any reward without risk..

      But if you want a return on your money you can transfer some of your savings to someone who promises you a return and who you have confidence in.

      That might be a bank – who promises to take your investment (they will banned from calling it a deposit) and lend it and pay you a slice of the interest on the loan. But just like every other type of investment the banks will not have a public guarantee. If they are incompetent and go broke you lose your money. Which is no different to what happens if you buy a share and the company goes broke or you buy a company bond and the company goes broke.

      If you want to play it very safe you might invest in a company that makes modest first mortgages where there is very little risk that the loans will not be repaid. The returns are likely to be modest but then so is the risk.

      Giving the public access to the RBA balance sheet so they can save risk free will allow a proper distinction to be drawn between saving and investment.

      More importantly as the core of the monetary system will now be the rock solid RBA balance sheet that pays zero interest on deposits and not interest bearing private bank credit, the public will become much less tolerant towards the inflation that the private banks currently drive and demand (as it helps make their debts more easy to peddle) and inflation resulting from irresponsible government spending.

  7. So I don’t get the MB view, if the household debt is soooo much that it cannot handle the rate hikes requited to bring inflation into control, doesn’t that make the country itself a HIGHER RISK and so, the bond yields need to reflect those higher risks?
    Or are we just throwing out every principle from our finance textbooks and living in a bizzario world where the interest rates are going to be low BECAUSE of the high leverage??
    Why would you lend money to the aus govt lower than the u.s. govt when their debt levels are lower and they are more committed to price stability?
    Given the inflation is supply side, would a lower currency just cause a bigger hit to households? Not in the form of mortgage payments, but in the price of petrol, price of fertiliser and all white goods?
    I bet if rba wasn’t doing anything, mb would still be here whining that it is a policy mistake not to do anything. That’s because the only options left now are policy mistakes. And noone wants to admit that.

  8. In the long run higher interest rates are desirable. The current asset bubble is bad for the economy in the long because it props up bad businesses and redistributes wealth from productive income earners to non-productive holders of capital. I am tired of non-competitive companies propped up by cheap credit and unproductive assets sucking the air out of the productive economy.

    Never let a good crisis goes to waste. Raise interest rates and turn the money printing machine back on. We need structurally higher inflation, wages and interest rates to prick the asset bubble.