Whatever Happened to Australia's 2018 Interest-Rate Hike?

(Bloomberg) -- The Reserve Bank of Australia has slipped even further back in the global race to tighten.

Just over four weeks ago, traders were pricing in an Australian interest-rate hike -- the first since 2010 -- as a done deal for the fourth quarter. They’ve since backtracked to bet that Governor Philip Lowe will maintain a record-low 1.5 percent for at least the rest of the year.

Growing doubts about household finances, already straining under record debt and stagnant wages, together with a deflationary retail sector and job numbers still some way off full employment, have tempered expectations. Lowe’s adoption of the word “gradual” to describe the likely pace of unemployment falling and inflation returning to the 2.5 percent midpoint of the RBA’s target, helped drive the pullback.

“The RBA will be patient in its approach to policy normalization,” said Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada. The governor’s comments and recent data “are consistent with our base case for the RBA to stay on the sidelines in 2018.”

This week sees a suite of economic data that wraps up the fourth quarter and provides early insights into this year: company profits, the current account and gross domestic product for the final three months of 2017 are released; as are January building approvals, retail sales and trade. Add to that a rate decision, in which all economists expect no action.

The following four charts outline why the RBA isn’t budging on Tuesday, or indeed for the likely foreseeable future.

A key turning point for markets was Jan. 31 -- when fourth-quarter data showed both headline and core inflation remained below the bottom of the RBA’s 2 percent to 3 percent target. Lowe’s mid-February testimony to lawmakers also made it clear he was in no hurry to tighten. As the governor has said, Australia didn’t have to ease as much as other countries -- having dodged the 2009 global recession -- so there isn’t the urgency to hike.

Australia’s floating exchange rate means it’s not obliged to move policy in lockstep with global peers. With the country’s bond yields now dropping decisively below the U.S.’s for the first time since 2001, the Aussie has weakened this year. Still, while rate differentials -- particularly over longer periods -- are an important influence on the currency, it’s also heavily correlated with commodities, which have shown renewed vigor.

Australia’s wage woes are very much in line with the rest of the world. Growth in pay packets has slowed to levels not seen since the last recession in 1991 -- despite a jobs bonanza last year. The RBA is adamant that full employment -- estimated at a jobless rate of about 5 percent -- will force firms to pay employees more in order to hold existing staff and attract new workers.

One problem: from the U.S. to the U.K., full employment has failed to ignite the expected spurt in salary growth. So until wages rise and flow through to faster inflation, Lowe and his colleagues are set to sit tight.

There are bright spots. Business conditions -- a key indicator the RBA monitors -- have soared to record highs, and in response non-mining firms are opening their checkbooks. Companies are investing more and they’re hiring -- as seen by 400,000 new jobs last year with a record three-quarters of them full-time. Now it’s just a matter of the labor market’s spare capacity being mopped up for the RBA to be ready to pull the rate trigger.

--With assistance from Kimberley Verschuur and Garfield Reynolds

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net.

To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Chris Bourke, Karl Lester M. Yap

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