Rate hikes this year? Forecasters are divided: Charts of the week
Markets expect the cash rate to hit 1% by December but many economists expect the Reserve Bank will be more cautious.
It’s tempting to use the US economy as shorthand for the world: it's the largest economy in the world and Wall Street accounts for more than half the market value of global equities. But when it comes to inflation that would be hasty.
Australia is not the United States. Consumer prices down under are moving in the same direction but at half the speed. As a result, some analysts expect Australia to buck the hawkish trend forecast for the US this year: multiple rate hikes and a start to quantitative tightening. That could set the stage for some Australian assets to outperform.
Prices are rising around the world thanks to government support payments, trillions in central bank asset purchases and supply chain snarls. The International Monetary Fund expects consumer prices to rise by 4.8% year-on-year across the developed world in the December quarter. Developing countries are looking at almost 6%.
Australian inflation is more subdued by comparison. The broad consumer price index (CPI) surprised to the upside with a 3.5% jump in the December quarter versus a year earlier but remains half the 7% notched in the US and below the 5.9% recorded across the pond in New Zealand. A separate measure that strips out volatile items, preferred by the Reserve Bank, hit 2.6%, comfortably within the Bank’s target range of 2%-3%.
Some forecasters expect price growth to slow and for inflation to remain rangebound this year. In a January poll of 24 economists by The Conversation, the average forecast saw underlying inflation peaking at 2.9% this year before declining in 2023. Two thirds expect rates to stay on hold until 2023.
Market watchers point to raft of factors for why inflation in Australia is rising more slowly: the Reserve Bank was late to start “quantitative easing”, strict lockdowns crimped growth in the second half of last year, lower energy prices relative to the US or Europe, higher workforce participation, and the way enterprise bargaining agreements stagger the pace of wage hikes.
It all adds up to leeway for the Reserve Bank to act cautiously in tightening monetary policy, says economist Dr Stephen Kirchner, director of the International Economy Program at the United States Studies Centre at the University of Sydney. With underlying inflation in the target range for the first time in six years, it is likely to wait and see if it hangs around, he says.
“Inflation back in the [RBA’s target] band is by itself not a strong argument for tightening monetary policy," he says.
"It’s just means you’ve got inflation where you want it to be. Lowe will be rightly cautious not rushing to tighten. Having undershot the target for so long he won’t want to risk a situation where they tighten too quickly, and inflation goes back below the band.”
Mixed bag for equities
If doves are right, a scenario is brewing where the US Federal Reserve raises rates, a process set to begin in March, while the Reserve Bank holds off for another year. Analysts are divided about how this scenario plays out for Australian equities.
An extra spell of low rates is good news for a local economy still emerging from the pandemic, says Jun Bei Liu, a portfolio manager at Tribeca Investment Partners. Australia lagged the global rebound last year due to lockdowns and stocks should benefit from robust growth as we play catch up.
“We have a situation where Australian equities are very attractive relative to the likes of the US market because our interest rate is still low and is going to be for quite some time,” she says.
“Our economic growth will pick up in pace relative to the US which will potentially slow somewhat due to the higher interest rates.”
Government stimulus in China, especially if it aids the commodity-hungry real estate, construction and infrastructure sectors, may also boost demand for Australian exports such as iron ore and coal, she adds.
One of a handful countries where inflation is lower now than before the pandemic, Chinese policy makers are cutting rates and priming government spending to combat the lingering effects of covid restrictions and a slowdown in the real estate sector.
But to the degree that local stocks take their lead from the US, selling on Wall Street in reaction to rising rates is likely to spill over to Australia, says Kirchner.
Investors don’t need reminding of the tight relationship between the local bourse and the US after a torrid January in share markets. The S&P/ASX 200 has fallen 8% year-to-date compared to a 7.6% decline for the S&P 500.
A vocal section of the economic commentariat disagrees with the doves and is expecting rising inflation to force the Reserve Bank to increase rates this year. Bond markets are betting the cash rate will be 1.1% by December. Economists at Deutsche Bank, AMP and Commonwealth Bank also tip a first hike by mid-year.
Predictions will be put to the test this week. The Reserve Bank board meets on Tuesday afternoon where it will discuss the fate of the quantitative easing program. Governor Philip Lowe addresses the National Press Club the following day where he is expected to outline the Bank’s thinking in detail. The Bank’s latest batch of economic forecasts, including inflation, are due on Friday.