Australia Real Interest Rates Rise in Challenge for Central Bank
Australia’s real interest rate has risen as deflation emerges in the economy -- and, coupled with a currency on a tear, could pose a challenge for a central bank otherwise content with its current policy mix.
Data out Wednesday showed consumer prices tumbled 1.9% in the three months through June, and were down 0.3% from the prior year, with even a key core measure that strips out price volatility turning negative on a quarterly basis. The effective tightening in real interest rates -- which are calculated by subtracting the inflation rate from the benchmark interest rate -- is happening just as the Reserve Bank of Australia wants easier credit conditions to help the economy recover from the Covid-19 lockdown.
The Australian dollar has surged 25% since a March 19 nadir as key commodity prices strengthened and the nation managed to contain the virus and reopen its economy earlier than expected.
In a review this month of its policy response to the pandemic, the central bank highlighted the option of lowering the cash rate and three-year yield target to 0.10%, from the current 0.25%. Governor Philip Lowe said the board believed the policy package it enacted in March remained the best course of action, but was prepared to do more if conditions deteriorated further.
“The RBA will unveil more policy stimulus in the coming months,” said Ben Udy, Australia economist at Capital Economics, who expects core inflation to remain below the central bank’s 2%-3% target for years.
“We expect the bank to launch traditional QE aimed at lowering long-term yields,” he said. “It is certainly possible that the bank opts for another form of stimulus, such as the cut to 10 basis points.”
Assistant Governor Christopher Kent, asked Monday whether the RBA could opt for for negative rates amid deflation, suggested this was highly unlikely.
“Interest rates at the moment are really not a constraint on the capacity or willingness of people to borrow,” he said. “It’s just aggregate demand is weak and companies are facing economic uncertainty.”
While some drivers of deflation are temporary, others are likely to prove more prolonged. Rents, which make up 6.8% of the CPI basket, fell by a record 1.3% last quarter, and are likely to fall further amid a collapse in the number of international students and tourists. Meanwhile, the large degree of slack in the economy will keep broader price pressures muted.
Su-Lin Ong, head of economic and fixed-income strategy at the Royal Bank of Canada, says a disinflationary trend is emerging. She notes that core inflation has been below the lower end of the RBA’s target for 18 consecutive quarters, a trend she expects to persist.
“Coupled with an unemployment rate that is set to remain well above full employment over its forecast horizon, policy will remain accommodative for the foreseeable future, with the bias toward further easing,” Ong said.
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