The Reserve Bank of Australia’s senior management team will testify before parliament on Friday, likely pressing the claim that interest rate increases are still a while away.
But will anybody be listening? Certainly money market traders have switched off.
Despite RBA Governor Philip Lowe again highlighting last week his preparedness to remain “patient” before tightening monetary policy screws, financial markets this week bet that rate increases will accelerate.
Traders now expect the RBA will raise its official cash rate five times before the year’s end, up from four just weeks ago.
Further out, market pricing suggests the RBA will deliver eight rate increases by August 2023, taking the official cash rate to 2 per cent from 0.10 per cent currently. As recently as December, financial markets expected it would take until early 2024 to get the cash rate to 2 per cent.
Also this week, yields on Australian 10-year government bonds hit their highest level since June 2019.
The trend is clear. Money market traders think the coming rise in interest rates will be soon, rapid, and punishing.
A group of economists is also betting that because central banks, including the RBA, have been slow to respond to rising inflation, the peak in interest rates will be far higher than anticipated.
The head of Australian economics at the ANZ Bank, David Plank, said money markets were underestimating how high the cash rate would need to rise this cycle, and forecast that it would approach 3 per cent in time.
“There is good reason to think the market is pricing a cycle that is too short and a peak that is too low,” Mr Plank said.
The idea the RBA has been selling, as recently as January, that it could be 2024 before interest rates rise, has now been forcefully binned.
To be sure, it was hoped that a recent flood of RBA communication, which included a policy meeting, a major speech by Dr Lowe, and the publication of new economic forecasts, would help see the divide between markets and the RBA close, at least a little.
Instead, it has all moved the wrong way.
Dr Lowe conceded last week that there was a “plausible scenario” that might deliver a rate increase in 2022, but beyond that his main message was that he wanted further evidence that inflation was entrenched in the RBA’s 2 per cent to 3 per cent target band.
Full employment may also be reached in coming months too, a prize Dr Lowe wants to push for.
When he appears before parliament on Friday, Dr Lowe will be joined by his deputy Guy Debelle and the central bank’s head of economics Luci Ellis.
Together, they will argue that Australia’s inflation environment is not as threatening as in countries like the US and the UK, and that there is time to wait and see before raising rates.
That is all well and good, but the RBA failed to see a big jump in fourth-quarter inflation. Many argue that it is still underestimating the risks around wages growth, which could quickly push inflation above the target band and keep it there.
With markets now ignoring the RBA’s guidance entirely, there is a lot at stake for the central bank’s credibility. It may be proven right over time but right now the RBA’s singing a song that’s out of tune.
The Wall Street Journal
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