People look at a smartphone in front of electronic boards displaying stock information inside the Australian Securities Exchange, operated by ASX Ltd., in Sydney, Australia. (Photographer: David Moir/Bloomberg)

This Algorithm Tracks What Australia's Central Bank Is Really Thinking

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The latest index for Australian market watchers doesn’t track stocks, bonds or currencies. It uses an algorithm to track the tone of central bank Governor Philip Lowe’s words.

Australia & New Zealand Banking Group has finely crunched the prose of the Reserve Bank of Australia’s two governors over the past decade to see if their rate statements signal a clear bias. The results correlate positively with rate moves and show that the central bank – which hasn’t provided any forward guidance since it last cut interest rates a year ago – may finally be turning hawkish.  

A monthly obsession of Aussie traders, analysts and journalists, the RBA’s rate statement can often feel like a pain-staking puzzle of ‘spot the difference’ when searching for new signals. But child’s play it isn’t: changing just one word can swing the fortunes of the currency in seconds. And with markets forecasting rates at a record-low 1.5 percent for at least another year, the hunt for clues on Lowe’s thinking has only intensified.   

“The RBA’s policy bias is starting to lean in a slightly hawkish direction,” said Sydney-based ANZ economist Giulia Lavinia Specchia. “We don’t think the signal is yet strong enough to shift our view from ‘on hold,’ but the evolution of the RBA’s language clearly bears watching.”

In a nutshell, here’s how it works: first, an algorithm identifies key words and sentences from each rate statement. The results are then run through Google’s search engine to see if they are associated more with the word ‘hawkish’ or the word ‘dovish’ across the web. A score is then allocated to each of those searches, depending on hits.

A final average score is then calculated for the whole statement: anything above 1 is deemed as more hawkish and vice versa. The methodology follows research by U.S. economists David Lucca and Francesco Trebbi.

The result? According to the index, the RBA turned neutral in March for the first time in five years. It’s bias score then edged upwards, with ANZ suggesting that Lowe’s increased focus on financial stability has helped tip the balance.  The governor earlier this month said expectations of an upward rate move, albeit some time off, seemed reasonable.

While reading between the RBA’s lines for the next rate increase may be premature at this stage, the index’s creators say it appears to lead changes in the cash rate by about six months.

“We found that our index is a useful leading indicator of changes in the cash rate and shifts in market pricing,” said Specchia.

 

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