Action by RBA a warning on interest rates

The Reserve Bank has given its strongest signal yet that the first rate hike will happen earlier than expected.

Reserve Bank of Australia governor Philip Lowe will reveal a new inflation outlook in the statement accompanying next Tuesday’s board meeting. Picture: James Brickwood.

The Reserve Bank has provided its strongest signal yet that it ­expects rates will need to rise sooner than anticipated, after it effectively abandoned a pledge during the height of the pandemic to keep bond yields pinned at 0.1 per cent until 2024.

Economists said RBA governor Philip Lowe after next Tuesday’s board meeting would reveal a hike in the cash rate to 0.25 per cent was now likely in 2023 – a year ahead of schedule.

The trigger was the decision by the RBA on Friday morning to not intervene to get the April 2024 bond yield back down to its 0.1 per cent target, after it had blown out to five times that level following stronger than anticipated inflation figures on Wednesday.

The RBA implemented the so-called yield curve control ­program, or YCC, in March 2020 – initially at 0.25 per cent for bonds out to three years, falling to 0.1 per cent from November 2020 – as a way to cement expectations that rates were on hold for years to come, and to help lower ­borrowing costs across the ­economy during the Covid-19 pandemic.

It had diligently maintained that 0.1 per cent YCC target by buying the April 2024 bond where necessary (purchasing bonds pushes the price up and the yield down).

But in recent days that bond yield had moved firmly higher. The upward pressure on the yield intensified after September quarter consumer price index data on Wednesday showed underlying inflation lifted to 2.1 per cent – pushing into the RBA’s 2-3 per cent target range for the first time since 2015.

Economists interpreted the RBA’s decision to not reassert control of the April 2024 bond yield as a clear signal that the central bank now thought rates would need to rise sooner than that.

Analysts quickly moved to bring forward the expected date for a lift in the cash rate to 0.25 per cent by about six months to late 2022 or early 2023.

Citi chief economist Josh ­Williamson said “the material shift to the labour market and ­inflation outlook suggests that the board will be comfortable changing its forward guidance that conditions to lift the cash rate will be met by early 2023, instead of early 2024”.

The RBA has not hiked rates since November 2010.

ANZ head of Australian ­economics David Plank said Dr Lowe on Tuesday would likely also announce the end of the YCC program.

In addition to pushing the key bond yield higher, markets are also now aggressively pricing in a 1 to 1.25 percentage-point lift in the cash rate over the coming 12 months, with the first move as soon as March or April.

But AMP Capital chief economist Shane Oliver said investors were likely getting ahead of themselves, amid a chaotic few days of bond trading.

Dr Oliver said such a rapid move higher in rates would be a “shock” to the economy and drive houses price down at a time when the post-Delta recovery in previously locked-down states was still in its early stages.

With that in mind, Dr Lowe would make clear in Tuesday’s statement that a hike remained some distance away, Dr Oliver said.

Beyond Covid-related price increases in segments such as housing construction materials and imported goods such as cars and furniture, Dr Lowe has repeatedly said that a meaningful lift in wages growth – to at least 3 per cent – remained central to sustainably higher inflation over the medium term.

Aside from anecdotal evidence, there remains little hard data that labour shortages are feeding through to economy-wide pay gains.

The Australian Bureau of Statistics’ latest wage price index showed only 1.7 per cent increase over the year to September – barely half of the headline ­inflation rate, meaning workers’ “real” pay went backwards.