4th November 2021
“Who would’ve thought” – Anonymous
The quote above sums up what we have lived through globally over past two years we’ve just had. They have been nothing short of tumultuous, terrifying, and full of hope. It is something most of us will never experience again in our lifetime, yet the resilience of the human spirit has once again shone bright. From an economic standpoint it has never been more challenging in recent history for policy makers trying to keep the wheels spinning. After years of accommodative monetary policy, central banks, the world over, are now trying to figure out how to return world economies back to some sort of equilibrium by taking the foot of the proverbial stimulatory pedal.
Following the September quarter Inflation Report, Westpac confirmed their forecast, that the first-rate hike (15 basis points) by the RBA (Reserve Bank of Australia) will be in the March quarter, 2023, with the February 1 Board meeting being the most likely timing. We have heard this before, but Governor Lowe is adamant that the first-rate hike is more than likely going to be early 2024. That said, the markets are saying something completely different with the RBA’s YCC (Yield Curve Control) nothing more than a token initiative at conveying the RBA’s internal thinking. The chart below clearly shows the divergence between the RBA’s attempt to keep the 3-year bond at 10bps and the markets decision to push the other way – this is incredibly significant as it highlights the stark divergence between what is intended and reality.
As we know that one of the keys determining variables for monetary policy is inflation, this past week has again been all about inflation and central bank expectations. While the headline Australian CPI print for Q3 was in line with expectations at 0.8%, the trimmed mean core was materially higher than forecast at 0.7%, taking the annual rate above the bottom of the RBA’s 2-3% year inflation target for the first time since Q3 2015 (2.1%yr at Q3 2021). The primary drivers of aggregate inflation in the quarter were new dwelling purchase prices (3.3% – see chart below) and auto fuel (7.1%). Notably for the outlook, the rise in dwelling purchase prices because of the unwinding of the Homebuilder grant was smaller than anticipated; the greater contribution of fundamentals in Q3 and the future unwind of this grant’s effect points to a stronger outlook for this component.
The below chart illustrates one of the reasons the markets are starting to worry about inflation, and why the yield curve has started to steepen sharply – both these factors placing upward pressure on this variable.
Post the surprise for Q3 trimmed mean inflation and the markets are now already pricing in three rate hikes to 0.75% by November 2022. However, as outlined by Westpac Chief Economist Bill Evans, he continues to expect the first-rate hike to come in February 2023, to be followed by a modest tightening cycle to 0.75% late 2023 and 1.25% in 2024. This sequence of hikes will occur after full employment is achieved (end 2022) and as inflation is sustained in the RBA’s target range.
Looking further abroad, the US Fed announced overnight that it will begin trimming its monthly bond purchases this month with plans to end them in 2022 but continues to believe any uplift in inflation will prove transitory. In other news the Euro Area’s labour market fared well through the pandemic thanks to wage subsidies, cyclically and structurally there is still considerable slack to erode via above trend growth. Therefore, the ECB is ready and willing to maintain asset purchases for a lot longer than the other central banks noted above. Indeed, it seems probable the open-ended Asset Purchase Program (APP) operational before the pandemic will continue indefinitely and, for a time, be supplemented by additional purchases after the pandemic envelope (PEPP) is closed end March 2022. Any move on interest rates by the ECB therefore seems distant.
Look forward to catching up next week!
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