Central Bank at Cusp of Reflation Trade Girds for Long Fight

(Bloomberg) -- The Reserve Bank of Australia signaled it’s ready for a prolonged battle with bond traders betting on a reflation wave sweeping across the global economy.

“The bank remains committed to the 3-year yield target and recently purchased bonds to support the target and will continue to do so as necessary,” Governor Philip Lowe said in a statement Tuesday, after keeping the main policy levers unchanged. “The bank is prepared to make further adjustments to its purchases in response to market conditions.”

The RBA has stepped up bond purchases to defend its yield target and in an effort to soothe market dysfunction. Australia and New Zealand both find themselves at the front line as early success in containing Covid-19 means they’re further along the road to recovery that will, potentially, trigger an unwinding of ultra-loose policy settings.

Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada, said the central bank’s unscheduled operations Friday to defend its yield target and doubling of its usual quantitative easing purchases Monday marked a shift in stance.

It signals “a preparedness to be more flexible, deploy its existing tools for better impact,” she said. That suggests the RBA “will err on the side of more, rather than less, accommodation with QE3 likely.”

After the upheaval in yields through February, market reaction was muted to the RBA’s statement today. The 10-year yield spiked seven basis points higher while the three-year yield was just under 1.2%, suggesting markets will continue to test the RBA with reflation bets. The currency trimmed its intraday decline to trade at 77.64 U.S. cents at 5:48 p.m. in Sydney.

Lowe indicated in his statement that the outlook was largely unchanged from the prior month: inflation will accelerate temporarily after the end of Covid-related price reductions; otherwise, consumer prices will rise 1.25% this year and 1.5% next.

The central bank won’t raise its cash rate “until actual inflation is sustainably” in its 2-3% target range,” the governor reiterated. This, he said, will require “materially higher” wages growth that in turn will need “significant gains” in employment to tighten the labor market.

“The board does not expect these conditions to be met until 2024 at the earliest,” Lowe said.

Central banks and bonds markets across the world have been locked in a showdown as efforts to keep borrowing costs low are being tested by inflation bets. Fed Chair Jerome Powell last week spent two days telling U.S. lawmakers the economy is in no state to be thinking about monetary tightening. European Central Bank President Christine Lagarde is “closely monitoring” debt yields.

Lowe said today the bank is “prepared to do more if that is necessary.” That echoed comments earlier today by The Reserve Bank of New Zealand, which said that it stood ready to ramp up bond purchases.

What Bloomberg Economics Says...

“Rather than resorting to expanding existing policy tools the RBA stuck with jawboning, stating that it doesn’t expect conditions to warrant an increase in interest rates until 2024 at the earliest.”

-- James McIntyre, economist

For the full note, click here.

Covid Recovery

Sentiment is strong in Australia, underpinning activity and hiring; on top of that, the nation’s largest export -- iron ore -- is hovering around $170 a ton, levels last seen a decade ago.

Economists estimate the economy expanded 2.5% in the final three months of last year from the prior quarter, ahead of data Wednesday. Yet, gross domestic product probably contracted 1.9% from a year earlier, they said.

The low cost of borrowing is fueling a rapid rebound in property with the housing market recording its largest monthly gain in 17 years and lending reaching a record high in January.

“Housing credit growth to owner-occupiers has picked up, but investor and business credit growth remain weak,” Lowe said. “Lending standards remain sound and it is important that they remain so in an environment of rising housing prices and low interest rates.”

©2021 Bloomberg L.P.