New RBA boss Michele Bullock lays out inflation busting plan

Michele Bullock’s comments are likely to be seized on by those tipping more interest rate hikes.

Michele Bullock has used her first official speech as Reserve Bank governor to define herself as an inflation buster.

And after a bruising year for the central bank, she has subtily reminded the government of the central bank’s independence when it comes to keeping the economy running on track.

Bullock’s comments during a speech at a Commonwealth Bank forum on Tuesday night are likely to be seized on by market hawks as tilting the balance in favour of a Cup Day interest rate hike if new inflation figures and the bank’s own internal forecasts both run ahead of expectations.

Former central bank government Philip Lowe, who pushed through a punishing round of cash rate hikes, in recent months used the language of patience when it came to returning inflation to target. Bullock says it is a narrow path, and she has a low tolerance if inflation starts falling more slowly than expected.

Indeed, Bullock says the decision to wait until 2025 to get inflation back into the target range “is at the end of our tolerance”.

New RBA Governor Michele Bullock at the RBA offices in Martin Place. Picture: John Feder for The Australian

Money markets are currently pricing in a one-in-four change of an interest rate hike at the November meeting, and that is likely to increase following signs inflation is starting to pick up again.

Rising petrol prices backed a jump in inflation during the September quarter to 1.2 per cent from 0.8 per cent in the previous quarter, official numbers released Wednesday show. Economists had tipped 1.1 per cent.

“The (RBA) board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation,” Bullock says.

The RBA boss says it is possible that inflation can come back down to its target range with the cash rate holding at its current level of 4.1 per cent – but she adds there are risks that this approach could see it moving more slowly than forecast.

With inflation holding sticky and economies like the US economy still running fast, global markets are taking another look for their outlook for interest rates, expecting they will hold higher for longer – or even keep lifting.

This outlook for inflation has been causing wild swings in bond markets and pushing up pricing across key borrowing benchmarks.

There are expectations interest rates globally will stay higher for longer. Picture: AFP

But it was deep in Bullock’s speech that she revealed views which may determine how the RBA plans to interpret its updated mandate. And importantly, this could set the tone on how interest rates move.

The backdrop to the speech is the RBA review released earlier this year, which recommended the central bank make more explicit a dual mandate of low and stable inflation and full employment. The widely held view is that the RBA has been placing a higher weighting on fighting inflation (which has a target) over achieving an undefined full employment target.

At a basic level, higher interest rates to fight inflation by slowing the economy is often regarded as being at odds with full employment. Having an explicit full employment mandate has stoked concerns the central banks would prioritise jobs over tackling inflation.

Critically, however, Bullock says “low inflation and full employment go hand-in-hand”.

“Low and stable inflation is a prerequisite for strong and sustainable employment growth because it creates favourable conditions for households and businesses to make decisions about how to use their resources,” Bullock says. The objectives are often complementary in the shorter term, she adds.

“That is certainly true when economic cycles are being driven mainly by strengthening or weakening demand … the policy response that returns inflation to target also moves the labour market towards full employment,” she says.

Nor should a central bank permit inflation to remain outside its target band for too long, given that inflation expectations will shift.

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Bears and bonds

Bond markets will continue to feel the pain as they work through a fundamental reset that has been driving much of the wild swings.

A sell-off in US bond markets pushed the yield on benchmark US Treasury 10 year bonds above 5 per cent on Monday to the highest levels since the global financial crisis. The big movements on the bonds that influence the price of money right through the world’s financial system – including Australia – has also been spooking stock markets and stoking fears of a broader economic slowdown.

The US bond sell-off has been underway over the past three months, pushing it deep into bear market territory. But the increasing pace of the sell down is the market’s way of saying the US “have to go a lot harder and higher” on interest rates to fight inflation, says Commonwealth Bank’s top markets boss Andrew Hinchliff.

Hinchliff, CBA’s Institutional Banking and Markets executive, was speaking to The Australian part way through the bank’s two-day conference for global debt investors being held in Sydney. Here some 150 debt issuers and investors are meeting, culminating in RBA governor Michele Bullock’s debut speech.

Hinchliff points out bond markets are trying to find a new level after central banks around the world have been pulling back their massive bond buying programs, or curbing Covid-era quantitative easing. And this has been removing demand. At the same time, countries like China and Japan, traditionally big backers of US debt, have switched their focus to bond buying at home to support their domestic economies.

“There’s two enormous pools of money that have technically disappeared or are disappearing on the demand side,” Hinchliff says.

“Then on the supply side, you’ve got governments — certainly the US government, with the foot firmly on the throttle with huge amounts of spending with things like the (Inflation Reduction Act). So the supply of bonds is very large,” Hinchliff says.

CBA’s top markets executive Andrew Hinchliff.

Australia too is playing its part on the supply side with $111bn in ultra-cheap loans given to Australian banks during Covid-19 pandemic by the RBA, set to mature by mid-next year. That means Australian banks will need to issue bonds on global markets.

Australian state governments are set to be big borrowers in coming years, although they represent a tiny fraction of global bond issuance by governments around the world.

While US bonds impact global rates, Australian 10-year bonds are being priced at around 4.8 per cent — roughly the same as the terminal, or neutral, cash rate over that period, suggesting the market remains in balance.

US bond yields retreated from 16-year highs on Monday after bullish comments from Bill Ackman and Bill Gross, as well as lingering demand for safe havens amid Middle East worries.

On Tuesday, the US 10-year Treasury yield later fell 6.6 basis points to 4.85 per cent, after hitting a fresh 16-year high of 5.02 per cent. The 30-year yield fell 8.3 basis points to 5.13 per cent.

The US is experiencing an “inverted yield curve” where longer term bonds that carry more risk are offering lower yields than short term bonds. All things being equal, this points to fears of a recession coming there.

But Australia has a steep yield curve where long-term bonds are paying more than short-term bonds — a sign of a market in balance.

This difference between Australia and the US reflects who the markets reckon have got a better chance of fighting inflation, Hinchliff says.

“Our economists would argue that we’ve got a far more interest rate sensitive economy driven more by floating rate mortgages and so every increase will have a disproportionately large flow-on impact in slowing the economy versus the US.”

Even so, CBA’s economists are tipping a 40 per cent chance of another interest rate hike in Australia on Cup Day, slightly higher than market betting.

The volatility across US bonds is not all bad news for Australia, Hinchliff adds. This means there has been a “very healthy appetite” for Australian corporate credit from global investors. Indeed, this attention is helping to keep pricing down while allowing companies to lock in longer term debt than they would normally consider.

Just last week Canberra sold a monster $8bn 30-year bond and the issue was rushed with demand for the paper from global investors. The bond secured more than $28bn in bids, helping to keep pricing relatively low.

“There’s a lot of people out there looking to allocate to fixed income here, because it feels like a far safer place to be than historically but with better risk adjusted returns”.

Originally published as New RBA boss Michele Bullock lays out inflation busting plan