RBA Faces Credibility Test as Markets Push Yield Envelope
Reserve Bank of Australia chief Philip Lowe faces a major communications challenge on Tuesday as speculation mounts he will scrap a bond-yield target after the central bank allowed a market selloff to continue without defending it.
Yields started surging after data last Wednesday showed core inflation jumped back into the RBA’s 2-3% target for the first time since 2015. At one point on Friday traders drove up the rate on the April 2024 bond, which the bank aims to keep at 0.1%, to more than eight times that level as the RBA skipped opportunities to hold the yield down.
A number of economists now expect the RBA to drop the yield target at the meeting. One early pointer to a potential U-turn would be the announcement of a press briefing after the meeting, which Lowe typically calls when there is a major policy change.
“What is the point of having the target if you don’t defend it?” said Diana Mousina, senior economist at AMP Capital Investors Ltd. “People will question their credibility, but at the end of the day they are still the central bank and people will still follow what they say and look at their communication very closely.”
The predicament the RBA finds itself in is the latest example of how unexpectedly strong inflation around the globe is putting pressure on central bankers to rethink their policy timelines as the tradeoff between supporting pandemic-hit economies and overjuicing prices shifts.
The Bank of Canada ended its bond-buying stimulus last Wednesday and the Federal Reserve is seen announcing a pullback of its debt purchases in the coming days. The Bank of England also faces inflationary forces that have markets anticipating a hike at Thursday’s meeting or the one just before Christmas.
Lowe has set out his stall as one of the world’s most dovish central bankers, having struggled for years to boost inflation. He says Australia doesn’t face the sort of price pressures seen in the U.S. and U.K.
He predicts interest rates will remain at a record-low 0.1% until 2024, by which time a tight labor market should drive faster wage growth for sustainable inflation.
In tandem with the bond selloff, swaps traders boosted bets on an early start to Australia’s tightening cycle. They’re pricing in a first hike of 15 basis points by May and two more increases by the end of 2022.
While most economists see the market bets in Australia as an exaggerated response to one inflation report, many of them have also brought forward their rate hike forecasts. The median estimate among surveyed economists is for a 15 basis point hike in early 2023.
Indeed, with vaccination rates surging and New South Wales and Victoria states emerging from protracted virus-induced lockdowns earlier than expected, the portents for the economy’s rapid recovery are good.
Job advertisements data released Monday supported that view, climbing 6.2% in October from a month earlier. It has now returned to a June peak set prior to the most recent delta lockdowns, according to Australia & New Zealand Banking Group Ltd.
What Bloomberg Economics Says
“While underlying inflation has temporarily returned to the target band, conditions for inflation to be sustained -- a broad, sustained, pickup in wage growth -- remain elusive.”
--James McIntyre, economist. For more, click here
The strong inflation reading appears to have caught the RBA flat-footed in a pre-meeting period during which it prefers not to comment on policy. That has left a void to be filled by investors and economists until the central bank gets its chance to explain itself on Tuesday.
“The RBA had built a lot of reputational capital from its pandemic interventions, but that risks significant undoing now if the framework is abandoned very early,” said JPMorgan economist Ben Jarman.
He said the risk from scrapping the yield target on Tuesday was that policy will prove to be less stimulatory in future downturns, “under the fear that commitments can be pulled at short notice.”
Yet even if the RBA decides to leave policy and guidance unchanged this week it will still come out bruised, according to Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada.
“The market would believe them even less than they do now, if that is possible,” she said.
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