Australian Bond Exchange Weekly Update
Friday 15th March
Key points
- Structural reform needed to fix Australia’s productivity slump
- U.S. inflation accelerates as unemployment hits 2 year high
- Is a Japanese rate pivot imminent?
- European Central Bank holds – expects inflation to hit 2% by 2025
Global Cash Rates & Inflation
- The Reserve Bank of Australia (RBA) Cash Rate now sits at 4.35%pa and the annual inflation rate in the year to January is 3.4%.
- The US cash rate (policy rate) is currently between 5.25%-5.5%pa, and the annual inflation rate in the year to February is 3.2%.
- The Bank of England Bank Rate currently sits at 5.25%pa to fight an inflation rate of 4.0% in the year to January.
- The European Central Bank Cash Rate (deposit facility) is 4.0%pa, to fight an annual inflation rate of 2.8% in the year to January.
Structural Reform Needed to Fix Australia’s Productivity
Speaking at the AFR’s Business Summit this week, federal treasurer Jim Chalmers proclaimed that persistent and weak productivity growth is reducing living standards in Australia.
Productivity growth has been trending lower in Australia since the early 2000s, attributable to various reasons including weak business investment, clogged supply chains and a lack of skills and labour.
Also speaking at the Summit, former federal treasurer Peter Costello said that there was too much reliance on monetary and fiscal policy to prop up economies, and that structural reform was needed.
While Chalmers cautioned that a 2.2% growth rate over the next four decades, as forecast in the Government’s Intergenerational Report, was not aspirational enough, Costello cast doubt on some of Australia’s existing tax settings and recent industrial relations changes which were inhibiting growth.
U.S. Inflation Accelerates as Unemployment Hits 2-Year High
The annual rate of inflation in the U.S. picked up in February, increasing to 3.2% from 3.1% in January.
The annual inflation rate has eased significantly from the June 2022 highs of 9.1%, but this pace of easing has slowed markedly, prompting concerns over “the last mile” and whether interest rates will need to remain on hold for longer than anticipated.
While many pundits have been calling for rate cuts as soon as May, the latest data could see projections pushed further out.
On the U.S. jobs market, unemployment increased to 3.9% in February, its highest level in 2 years however, the economy is still in robust shape and was able to add 275,000 jobs, beating estimates of 200,000.
Unsurprisingly, the word recession has seemingly exited the public lexicon, but the possibility of a hard landing scenario is being severely underestimated, according to J.P. Morgan’s Jamie Dimon.
The former RBA governor Philip Lowe and BlackRock’s Global Chief Investment Strategist Wei Li also issued cautionary comments about the risk of a resurgence in inflation resurgence, which would likely trigger additional monetary tightening – something which markets are not accounting for.
Is a Japanese Rate Pivot Imminent?
While the ultra-low interest rate environment may seem like a distant memory, in Japan the official policy rate remains at -0.10% – but that could be about to change.
Despite the annual inflation rate only sitting slightly above the Bank of Japan’s (BoJ) target of 2%, expected wage increases (among other things) are prompting speculation that policymakers could end negative interest rates this month.
Economists project wage hikes of about 3.90% on average at the annual ‘shunto’ wage talks, exceeding a 3.58% deal struck in 2023 which was the highest in three decades.
Should Japanese interest rates climb higher as part of any monetary policy normalisation, this could trigger heightened volatility in financial markets as institutions unwind positions and sell investments as capital is ‘repatriated’ back to Japan.
European Central Bank Holds – Expects Inflation to Hit 2% by 2025
The ECB held its key interest rates again last week, but President Christine Lagarde hinted that a June rate cut could be a possibility.
“We are in the disinflationary process and are making progress… but we are not sufficiently confident, and we need more evidence, more data – and we know this data will come in the next few months. We will know a little more in April and a lot more in June.”
ECB President, Christine Lagarde
Importantly, Lagarde mentioned that the Bank wouldn’t need to wait for headline inflation to reach its 2% target before taking any interest rate decision.
The ECB also lowered its inflation forecast for the year from 2.7% to 2.3% and currently expects inflation to return to its 2% target in 2025.
Final Thoughts
While inflation has eased, there remains a litany of challenges which threaten to keep inflation higher for longer.
From geo-political tensions and trade fragmentation to ageing demographics and the green energy transition, investors should remain cognisant of these drivers and how they could impact financial markets over the medium-to-long term.
This underscores the importance of maintaining a balanced portfolio which is appropriately positioned to respond to any unexpected eventualities.
Week Ahead
- RBA interest rate decision
- Federal Reserve interest rate decision
- Bank of Japan interest rate decision
- Bank of England interest rate decision
- UK inflation rate
*Data accurate as at 15.03.2024
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