Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 444

Happy RBA refuses to blink while market runs ahead

Reserve Bank (RBA) Governor, Philip Lowe, looked surprisingly happy this week, given the recent criticism of his judgement a few months ago that conditions for an increase in cash rates would not be met until 2024. Both wages growth and inflation are much stronger than he expected, but Lowe sees this as an early achievement of two RBA targets.

Although he conceded the RBA does not really know what's happening, he seems delighted with progress. Underlying inflation is up around 2.5% for the first time in seven years and the unemployment rate is heading for a 50-year low. In his speech to the National Press Club, Lowe argued that low rates and bond buying have done exactly what they were supposed to and "More people have jobs than ever before. It's a real benefit to people and the community."

When challenged that he is moving too slowly on rates, he reminded the audience that inflation has just hit the mid point of the RBA 2-3% target. He is prepared to wait before moving, seeing many factors such as supply chain blocks as temporary. Although he said a rate rise in 2022 is 'plausible', he believes the market's expectation of four rises this year is highly unlikely. Here is where the market is pricing short-term rates over coming years.

RBA Board meeting

The RBA made important announcements on Tuesday this week which will set the tone for interest rates, and everything that flows from them, for the rest of 2022 and beyond.

First, the RBA decided to cease further bond purchases under its stimulus programme, as the economy now seems resilient enough to sustain a recovery. Since the start of COVID, the RBA's balance sheet has more than tripled to around $640 billion.

Here are some highlights of the monetary policy announcement:

"The RBA's central forecast is for GDP growth of around 4¼% over 2022 and 2% over 2023 ... The labour market has recovered strongly, with the unemployment rate declining to 4.2% in December ... The RBA's central forecast is for the unemployment rate to fall to below 4% later in the year and to be around 3¾% at the end of 2023."

"Inflation has picked up more quickly than the RBA had expected, but remains lower than in many other countries. The headline CPI inflation rate is 3.5% is being affected by higher petrol prices, higher prices for newly constructed homes and the disruptions to global supply chains. In underlying terms, inflation is 2.6%. The central forecast is for underlying inflation to increase further in coming quarters to around 3¼%, before declining to around 2¾% over 2023 as the supply-side problems are resolved and consumption patterns normalise."

"As the Board has stated previously, it will not increase the cash rate until actual inflation is sustainably within the 2 to 3% target range. While inflation has picked up, it is too early to conclude that it is sustainably within the target band."

Governor's speech to the National Press Club

Although much of his speech was a confession that the RBA's forecasts had been wrong in 2021, Lowe was upbeat about the economic recovery.

"That recovery is being underpinned by a number of factors. These include household balance sheets that are in generally good shape, with households having accumulated more than $200 billion in additional savings over the past two years. An upswing in business investment is also underway and there is a large pipeline of residential building to be completed over the next year or so. The decline in the unemployment rate has been accompanied by a welcome decline in underemployment, which is at its lowest rate in 13 years."

While he accepts inflation will increase modestly, he expects supply problems will be resolved. He said wages growth remains low and he will be patient reviewing monetary policies. Several times in response to questions, he emphasised that underlying (trimmed mean) inflation has just entered the target range, and that is a good thing. He wants inflation neither too low or too high.

"We are in the position where we can take some time to obtain greater clarity on these various issues. Countries with higher rates of inflation have less scope here. The Board is prepared to be patient as it monitors the evolution of the various factors affecting inflation in Australia."

And there was no mistaking his pride in the unemployment achievement:

"It is also relevant that Australia is within sight of a historic milestone – having the national unemployment rate below 4%. This is important because low unemployment brings with it very real economic and social benefits for many Australians and their communities. Full employment is one of the RBA's legislated objectives and the Board is committed to playing its role in achieving that objective, consistent with also achieving the inflation target."

When asked whether he would borrow at a fixed or floating rate if he had a mortgage, he was not prepared to commit, but rather, he advised borrowers to manage their obligations with a suitable buffer.

Although we like to think the RBA has some magical insights, this week confirmed that the information that will determine interest rates this year has yet to be released, and the Governor is guessing as much as any economist.

 

Graham Hand is Managing Editor of Firstlinks. This article is general information and does not consider the circumstances of any investor.

 

5 Comments
Bruce Bennett
February 02, 2022

In past cycles the RBA relied on the cash rate to manage monetary policy. This time it has two levers it can pull - the cash rate and $600 billion of bonds on its balance sheet.
Grateful if someone can tell readers how the RBA might use these levers if it wanted to reduce inflation and what would be the impact of each one?

Kevin
February 05, 2022

Hi Bruce, as no one else better qualified has given you an answer I thought I'd provide my view...
Likely you're most familiar with the cash rate 'lever' - as the RBA increases the official interest rate the cost of servicing loans (both for individuals and businesses) is increased, this means less money available for discretionary spending or investment, which slows the economy and therefore (in theory) inflation.
To some extent Australian banks are already increasing their loan rates (independent of the RBA) since the RBA terminated its emergency Term Funding Facility (an extremely low cost loan facility to the Australian banks) which means they must now source some of their funds from overseas at higher rates.
The second 'lever' is Quantitative Tightening, where the RBA reduces its balance sheet rather than expands it. Until recently the RBA was "printing" new money then purchasing bonds with that money. They purchased at prices that ensured the yield of those bonds remained low. Their intention appears to be to hold those bonds until maturity, but crucially, not renew them. As best I can tell this means the RBA will slowly replace its portfolio of bonds with cash. Presumably the cash will be removed from the RBA's balance sheet, thus shrinking its balance sheet. This reduces the volume of money in the system.
If "printing" new money (Quantitative Easing) was expressly used by the RBA to cause inflation, then logically, the opposite will happen as the RBA reduces its balance sheet.
So as best I can tell the RBA has three 'levers' it can pull. One of which (the Term Funding Facility) its already pulled...
Hope this helps...

Peter
February 02, 2022

The dynamics of our bank balance sheet risk management is driven largely by flows in our fixed rate home loan market. The banks are DEMANDING our central bank validate the change in market pricing right across our yield curve by changing the official cash rate and untether the 3 month reference rate so they can flip the curve. Paying 5 yr fixed at 1.92% and receiving 3 month BBSW at 0.07% is a very unprofitable equation that needs to be rectified immediately, they say.

"Patience is a Virtue" and our Governor Lowe has it in spades!!

The social conscience of our Governor is legendary. He will help keep interest rates low for an inordinate period of time. Our unemployment rate is now 4.2% and heading toward the 3's. He would be so proud of that and will make sure it stays there and goes even lower.

Peter Symonds
February 02, 2022

Philip Lowe and his team are worried about wage rises of 3% and meanwhile cost of housing is up 100% in some areas. Thanks to QE and zero interest rates. The social cost of his patience is huge, families are breaking apart as children move interstate to find affordable housing. What sort of community will it be when younger generation cant afford to buy in the area they have grown up in? 

William McMullin
February 06, 2022

Little to late for this. I left Melbourne to live in a more affordable market. That landed me in Darwin. Darwin then became too expensive where I was and am currently paying $2600 per month for a small 300m2 home. Once again, we are being forced out, and leaving to Townsville where are our costs are cut in half (we bought). I was sick and tired of housing insecurity.

 

Leave a Comment:

RELATED ARTICLES

Howard Marks on selling versus staying invested

Five strategies to match your investing to your behaviour

Changing times as share investors settle in for the long haul

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Welcome to Firstlinks Edition 552 with weekend update

Being rich is having a high-paying job and accumulating fancy houses and cars, while being wealthy is owning assets that provide passive income, as well as freedom and flexibility. Knowing the difference can reframe your life.

  • 21 March 2024

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Latest Updates

Retirement

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Shares

On the virtue of owning wonderful businesses like CBA

The US market has pummelled Australia's over the past 16 years and for good reason: it has some incredible businesses. Australia does too, but if you want to enjoy US-type returns, you need to know where to look.

Investment strategies

Why bank hybrids are being priced at a premium

As long as the banks have no desire to pay up for term deposit funding - which looks likely for a while yet - investors will continue to pay a premium for the higher yielding, but riskier hybrid instrument.

Investment strategies

The Magnificent Seven's dominance poses ever-growing risks

The rise of the Magnificent Seven and their large weighting in US indices has led to debate about concentration risk in markets. Whatever your view, the crowding into these stocks poses several challenges for global investors.

Strategy

Wealth is more than a number

Money can bolster our joy in real ways. However, if we relentlessly chase wealth at the expense of other facets of well-being, history and science both teach us that it will lead to a hollowing out of life.

The copper bull market may have years to run

The copper market is barrelling towards a significant deficit and price surge over the next few decades that investors should not discount when looking at the potential for artificial intelligence and renewable energy.

Property

Global REITs are on sale

Global REITs have been out of favour for some time. While office remains a concern, the rest of the sector is in good shape and offers compelling value, with many REITs trading below underlying asset replacement costs.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.