Will rates go up? Will rates go down?
Come in spinner!
There’s a lot of people talking interest rates in both directions right now.
The inflation data last week sparked a few rounds of grumble and rumbling that maybe a rate hike was now on the cards. A few eyes were watching the fall of the coins very nervously.
Could that be true? Are rates on the rise?
It’s true that the inflation figures did come in stronger than expected, but not by a lot. Headline CPI rose by 1.0 per cent in the September quarter, to be 2.3 per cent higher over the year.
That’s still squarely within the RBA’s target band.
Remember, the RBA targets annual inflation of between 2 ~ 3 percent.
But it’s the quarterly strength that took a few people by surprise. Annualise that rate and you’re looking at inflation of 3.5 ~ 4 percent. A CPI print of 4% would likely be enough to provoke an immediate response from the bank.
4 percent is way outside the target band, at least by the standards of recent experience (though of course some countries would be very happy with inflation of 4%!). The RBA has one of the best track records in the world in terms of hitting its inflation targets, and inflation’s been anchored firmly to the target band for almost twenty years.
It’s a stellar achievement.
In fact, inflation’s pretty much fallen from the public mind. No one really worries about it any more. I wonder if a lot of people even remember that that inflation is the RBA’s primary focus.
It’s not the economy, as such. Ideally it wants to keep a lid on inflation AND keep the economy humming along.
But if push came to shove, and the RBA had to chose between inflation and growth, it’d shoot for inflation, every time.
In fact, that’s the agreement it has with the government. The RBA, like pretty much every central bank in the world now, is an inflation targeter.
The idea is that interest rates on their own can’t be used to fix both inflation and growth. Sometimes, it’s one or the other.
And a key force keeping inflation down is the belief itself that inflation is going to stay down. Inflation expectations have a huge impact on inflation outcomes.
So the policy response to inflation needs to be ‘credible’. But credibility only comes if the public believes that if push came to shove, growth would be sacrificed for the sake of keeping a leash on inflation.
It sounds a bit scary, but it’s a doctrine that has served us incredibly well. With inflation and inflation expectations anchored to the RBA’s target band, we’ve been able to bring rates down to 50-year lows.
That has freed up the financial sector. With capital flowing more freely to business (and of course to investors like us), the economy has expanded quickly.
Everyone’s a winner.
But these wins did not come cheaply. Central banks had to ‘break the back of inflation’ first. That meant super high levels of rates, which meant recessions and a very grizzly public.
So the RBA would be very unwilling to let their hold on inflation be taken from them. Once it’s gone, it’s expensive to get it back.
And so you’d still have to think Glenn wouldn’t be thinking twice if push did actually come to shove.
I’m sure Glenn’s been happy to be every body’s hero with the rates cuts we’ve seen under his watch. But I’ve seen that steel in his eye. He looks to me like a man who’s as happy kicking heads as he is handing out flowers.
And he knows that his reputation, and the bank’s credibility, is built upon him doing just that.
And everybody in the markets knows that too. So that’s why a stronger than expected CPI print, sent a quick shiver down people’s spines.
So is a rate hike on the cards now? Could the RBA be forced into raising rates at the same time as the AUD bumps back toward parity, and growth outcomes remain soft?
It’s not a pretty scenario.
Personally, I don’t think it’s something to worry about for the time being. And I certainly don’t think they’re hitting the panic buttons down at Martin Place just yet.
Partly the CPI data had a couple surprises, but if you look at the ‘underlying’ (more stable) inflation measures, there’s no sign of an inflation break out there.
Second of all, a higher AUD actually offsets some of the risk of inflation.
That is, if the AUD is stronger, the things we buy overseas are cheaper for us, which means the final price when those goods hit Australian shores, is cheaper. Inflation falls.
So the increases we’ve seen in the Aussie dollar in recent months, will in the next 6 months or so, put back some downward pressure on inflation.
And if inflation remains a non-issue, which I expect it will, that puts the focus back on growth outcomes. And as the RBA noted in the last minutes, economic growth is still expected to remain “below trend over the next year or so.”
And at the same time, the AUD keeps pushing higher. And with a taper to Quantitative Easing now pretty much completely off the table in the US, there’s nothing driving US dollar strength, which means we could see the AUD trade even higher against the Yankee Doodle.
If that happens, and that happens before the a solid pick up in non-mining investment, particularly housing construction, then I think the RBA will have no choice but to cut rates even further.
But it’s too early in the game, and too late in the year for the RBA to do anything about that now. They’ll want to see how it plays out in the near term, and will be closely watching what happens to retail sales through the Christmas period.
If the Grinch is haunting Christmas, then I reckon we’ll see another rate cut, possibly in March or April next year (of course, in the absence of any other major surprises).
And so as investors, we can take heart that rate hikes still remain a long way off. And that also means that the fire that’s been lit under the property market will be left to run on full bore.
And the emerging boom in property we’ve seen will just keep charging ahead in the time being.
So let the CPI data be a reminder. At some point, the RBA may need to raise rates. That’s what they do. We need to build that into our planning.
But for the time being, under the firm hand of captain Glenn, it’s steady as she goes.