The Reserve Bank of Australia has gotten itself in a pickle.
Let’s start with yesterday’s interest rate decision. Or, rather, lack of decision.
Normally, when the rate announcement comes out, I quickly read the RBA notes to see what key words it uses. However, this time, I didn’t bother. Partly because I was at a horse race cheering on a losing filly. But mostly because nothing has changed.
The RBA did what was widely expected, keeping the cash rate on hold at 1.5%.
Because this was the anticipated outcome, the market barely reacted. The Aussie dollar fell 0.4% against the US dollar.
However, the no-rate-change decision helped push the S&P/ASX 200 over the 6000-point mark, eking out a 24-point rally to close at 6011 points.
This is fairly significant, as it’s the first time the index has traded above 6,000 points since early 2008.
How the ASX reacts from here will be interesting to watch. Low interest rates for the foreseeable future could mean more investors flooding into the market, hoping to seek out returns.
As Bloomberg explained yesterday, the RBA currently has a mixed bag of economic policy data, but no one in the market expects a rate rise this year. Bloomberg writes:
‘Australia’s economy is forecast to grow above trend and a burst of hiring is keeping unemployment down. Yet inflation, the last piece of the policy-tightening puzzle, remains weak and shows few signs of life.’
And now the bets are being placed on when the RBA will start increasing rates. Goldman Sachs blinked first, announcing that the RBA will most likely start raising the cash rate as early as February next year:
‘Neither economists or traders expect the RBA to shift rates this year. But Goldman Sachs Group Inc. sees next year kicking off with a February hike, with more economists expecting the same in the ensuing months.
‘Traders, meanwhile, have been pushing back their expectations and now see just over a 50 percent chance of an increase in October 2018, according to swaps data Friday. That climbs to 86 percent in November, the month after third-quarter inflation is released.’
One of the arguments for raising rates is that because the central banks of Canada, the UK and the US are raising rates, the RBA should too.
I’ll be honest — that’s the most absurd case for a rate rise I have ever heard. All three countries have different economies to us. Simply following in their footsteps makes no sense.
The biggest problem that the RBA faces at the moment, however, is that its economic data doesn’t match up with Australia’s economic reality. Gross domestic product and unemployment may be going in the direction the RBA wants, but inflation and consumption aren’t moving.
According to former RBA board member John Edwards, that doesn’t really matter. It just depends on what numbers the central bank chooses to look at. Edwards says inflation doesn’t need to rise for the RBA to start increasing the cash rate, saying:
‘If growth continues to pick up, then I think they’ll raise rates long before inflation returns to target. My view is influenced by what Phil Lowe’s been saying for many, many months on the perils to financial stability from very, very low interest rates. That was originally an argument for not lowering them any further. But it’s also an argument, as the economy picks up strength, for increasing them.’
However, this is where the problems come in. Central bankers can cherry pick the data they wish to use to back their board decisions all they want. But interest rates have been so low for so long, that any bump in rates would actually shock the Aussie market. And I’m not entirely sure that the mainstream rate watchers have factored this in yet.
If the RBA was going to raise rates at any point throughout next year, the market would need plenty of warning. It’s not like the pre-financial crisis, when the RBA raised the rate 1.25% in less than two years. Back then, our market was so fragile that we could absorb unpredicted rate rises.
We can’t now. Our delicate market and highly-indebted household sector won’t cope with sudden rate moves. Meaning that Goldman Sachs’ predicted rate rise in February next year is off the table.
In fact, I don’t think there will be any rate rises in 2018 at all.
Editor, Markets & Money
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