Australian Bond Exchange

ABEWeekly 11-11-2021

Market Update  


“Treat employees like they make a difference” – Jim Goodsight, CEO, SAS 

As anticipated, at their November meeting, the RBA (Reserve Bank of Australia) decided to end Yield Curve Control and remove specific date guidance on the timing of the first rate-hike. The Bank’s revised forecasts now point to a potential first increase in the cash rate in 2023, assuming the economy performs as expected. 

With only slight changes to key economic variables, it appears more likely that any interest rate increase will come in late 2023. For this case to be plausible it requires a very gradual response from inflation and wages to the current developments despite a strong recovery in the economy; supply constraints in goods and labour markets; rising inflationary expectations; some evidence of firms asserting pricing power; and firms having to resort to various tactics to hold down wage increases. 

Westpac Chief Economist Bill Evans continues to anticipate that the necessary conditions for the first interest rate increase will come much sooner than envisaged but we must remember that until these conditions happen forecasts, by nature, are always subject to change. The chart below illustrates just how variable forecasts can be. Essentially a 90% confidence interval suggests a 90% chance of getting the forecast right with that range. 


Showing their confidence in the economy, the US FOMC decided to start their taper immediately with a $15bn reduction in purchases in November and to lay out an unconditional schedule of further reductions to stabilise the size of their balance sheet by June 2022. However, the Committee and Chair Powell both stressed there would be no immediate follow-on for policy post the taper. 

To justify rate hikes, both maximum employment, and inflation above 2.0% yr. must be realised and expected to persist into the medium term. The Committee’s forecasts and Chair Powell’s commentary both point to maximum employment being possible by end-2022, justifying for a December 2022 first hike. But it would take another round of inflationary pressures, this time demand led, along with maximum employment to warrant an earlier move.  

Turning to the Bank of England, though their decision to keep policy on hold in November was regarded by the market as overly conservative, it was evident in their communications that they plan “over the coming months to increase the Bank Rate to return inflation sustainably to the 2% target”, “provided the incoming data, particularly on the labour market, are broadly in line with the central projections. 

The bottom line is that globally, we have been, without doubt, at the bottom of the interest rate cycle for way too long and Central Banks around the world are looking for the right opportunity to reverse, what has been an extraordinary period of historically low rates. For this to happen nothing has really changed. Inflation must be firmly within the 2-3% range, we need full employment and sustainable wages growth. 



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