As we in the UK return from the May Day bank holiday financial eyes turn to a land down under and its central bank.
At its meeting today, the Board decided to increase the cash rate target by 25 basis points to 35 basis points. It also increased the interest rate on Exchange Settlement balances from zero per cent to 25 basis points. ( Reserve Bank of Australia)
There is an interesting choice of phrasing in the rationale for this.
The Board judged that now was the right time to begin withdrawing some of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic. The economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than was expected.
The use of the word “resilient” in banking usually precedes a collapse so that is ominous but the real issue here is the failure on inflation. This contradicts the opening claim that now is the “right time” to act. We get more detail below on the inflation position.
Inflation has picked up significantly and by more than expected, although it remains lower than in most other advanced economies. Over the year to the March quarter, headline inflation was 5.1 per cent and in underlying terms inflation was 3.7 per cent.
The attempt to say they are doing relatively well on inflation rather hides the fact that they have been in summer so energy use will not be stressed like it has been in Europe. Let us see what winter brings and there is the usual effort to find a number lower than the headline without any explanation as to how people are supposed to live without food and energy.
Actually the whole concept of core or underlying inflation being useful as a concept has failed.
But domestic capacity constraints are increasingly playing a role and inflation pressures have broadened, with firms more prepared to pass through cost increases to consumer prices.
Indeed they expect inflation to get worse.
The central forecast for 2022 is for headline inflation of around 6 per cent and underlying inflation of around 4¾ per cent;
Before the interest-rates fairy turns up.
by mid 2024, headline and underlying inflation are forecast to have moderated to around 3 per cent. These forecasts are based on an assumption of further increases in interest rates.
As you can see we get some Forward Guidance here although they seem a bit confused as to what will in fact reduce inflation.
but as supply-side disruptions are resolved, inflation is expected to decline back towards the target range of 2 to 3 per cent.
That is a little awkward on two counts. Firstly if it is sim[ly a supply issue why are they raising interest-rates? Secondly if we look at Australia as the southern territories of China then this does not look so good on the supply front.
Hundreds of cargo ships are waiting to load or unload cargo. The reason for this big “jam” is the closure, or very slow operations, in the Port of Shanghai due to a COVID-19 lockdown ( World Cargo News)
The economy
According to the RBA things are expected to go well.
The central forecast is for Australian GDP to grow by 4¼ per cent over 2022 and 2 per cent over 2023. Household and business balance sheets are generally in good shape, an upswing in business investment is underway and there is a large pipeline of construction work to be completed.
Indeed they are very bullish on employment.
The resilience of the Australian economy is particularly evident in the labour market, with the unemployment rate declining over recent months to 4 per cent and labour force participation increasing to a record high. Both job vacancies and job ads are also at high levels.
Although I have my doubts about what unemployment measures tell us these days.
The central forecast is for the unemployment rate to decline to around 3½ per cent by early 2023 and remain around this level thereafter. This would be the lowest rate of unemployment in almost 50 years.
I am sure the sector below is doing well and some elements must be in quite a boom.
national income is being boosted by higher commodity prices.
This is shown by the RBA index.
Over the past year, the index has increased by 39.9 per cent in SDR terms, led by higher LNG, coking coal and thermal coal prices. The index has increased by 39.1 per cent in Australian dollar terms.
The rest of the economy I am more doubtful about because Australia is economically close to China and there is the issue of real wages and incomes. Adding to the supply crisis is this from the Hong Kong government earlier.
Real GDP contracted by 4.0% in the first quarter from a year earlier, and by 2.9% on a seasonally adjusted quarter-to-quarter basis. Looking ahead, the global economy will continue to face significant challenges in the near term.
Was it wages?
You could argue that this is the real cause of today’s interest-rate increase.
The Bank’s business liaison suggests that wages growth has been picking up. In a tight labour market, an increasing number of firms are paying higher wages to attract and retain staff, especially in an environment where the cost of living is rising.
Then there is more.
the more timely evidence from liaison and business surveys is that larger wage increases are now occurring in many private-sector firms.
I know some of you believed that interest-rates would only go up once wage growth rose and that theme is in play.
Quantitative Tightening or QT
This is now in play as well.
Consistent with this, the Board does not plan to reinvest the proceeds of maturing government bonds and expects the Bank’s balance sheet to decline significantly over the next couple of years as the Term Funding Facility comes to an end.
No actual selling which if you believe their rhetoric means they will hold them and make further losses.
The Board is not currently planning to sell the government bonds that the Bank purchased during the pandemic.
Comment
There are various consequences and issues here. The first is that timing matters in these things and the RBA is singing along with Carole King.
And it’s too late, baby, now it’s too late
Though we really did try to make it
Somethin’ inside has died
And I can’t hide and I just can’t fake it
Oh, no, no, no, no, no
(No, no, no, no)
It is too late to do much about the inflation surge and with economies plainly slowing will contribute to the downturn with this.
This will require a further lift in interest rates over the period ahead.
So having fed the inflation they may now exacerbate the downturn in a perversion of their role.
Next comes an issue for both Australia and its central bank. We are seeing rises in bond yields around the globe. Last night saw the US ten-year yield reach 3% and this morning the UK Gilt reached 2%. Even Germany has risen to 1%. In Australia the RBA applied its own form of Yield Curve Control and targeted 0.1% for the 3 year yield which is now 3%. So it will have losses to account for and Australians will be facing higher mortgage rates.
Added to this the statement seems to have missed out central bankers favourite topic which is house prices.
Total household wealth increased 4.5 per cent ($628b) in the December quarter 2021, reaching a record $14,677b, while wealth per capita rose to a record high of $566,541, according to figures released today by the Australian Bureau of Statistics (ABS).
Head of Finance and Wealth at the ABS, Katherine Keenan said: “Residential property prices continued to drive increases in household wealth, contributing 3.5 percentage points to the quarterly growth in household wealth. Prices increased 4.7 per cent during the quarter, reflecting record low interest rates, labour market recovery, and strong demand for housing.”
Podcast