Given Australia’s robust economic growth driven by high export prices, low unemployment rates and evidence that wages are rising from a tawdry basis, there is compelling reason to normalize spot interest rates to a cost of capital that is neither contracting nor expanding.
The problem is that while the RBA has repeatedly claimed that this “neutral” level is at least 2.5 percent (or a chunky 175 basis points above the pre-pandemic spot rate), the truth is that the RBA has no idea where “neutral” is. is real. You won’t know until you get there.
crappy prediction
The 2.5 percent estimate that the RBA is spinning is yet another prediction not worth the paper it’s written on — much like her opinion in early March 2020 that the pandemic wasn’t a big deal and then the excessively pessimistic subsequent predictions for a deep recession.
Given the unparalleled sensitivity of the Australian economy — dominated more than any other by a preponderance of floating-rate debt over fixed-rate debt — to changes in interest rates, a prudent policymaker would gradually raise the spot rate in default, 25-month basis point increments each month and nowcasting the real-time data streams to assess impact. That can get you to 2.5 percent, or you have to stop way below that figure.
Ironically, this was exactly the logic the RBA used to rationalize its initial 25 basis point gain in May, which ran counter to the 15 or 40 basis point gains economists and the market were expecting. The RBA explained that it rejected 15 basis points because it would be “inconsistent with the historical practice of changing the spot rate in increments of at least 25 basis points.” And it struck back 40 basis points because a 25 basis point move would “help to signal that governance has now returned to normal operating procedures after the extraordinary period of the pandemic.”
So consumers must conclude that the RBA signals that they are facing an inflationary crisis that warrants radically higher rates, as they have slashed their budgets with two consecutive, and highly unusual, increases of 50 basis points and an extraordinary total of 125 basis points, point increases in just two months (or more than three meetings from 4 May to 6 July)?
The crisis is apparently so bad that the RBA is further conditioning households through the media to prepare for an unprecedented third increase of 50 basis points in August, meaning that interest rates would have risen by a whopping 175 basis points in just three months (or more than four meetings).
The last time this happened was in 1994, when the RBA’s spot rate this year was about five times higher than its starting point (so the proportional change in interest payments was a lot less). And in 1994, the debt-to-income ratio of households was only 44 percent of its current level. Simply put, Australians were a lot less sensitive to interest rate changes 28 years ago.
CBA economist Gareth Aird says that “despite the unemployment rate of 3.9 percent, real wage results are the lowest ever since a tightening cycle”. And yet households have seen the most aggressive rate hikes in decades, combined with very negative real or inflation-adjusted wage growth.
Economic crisis
This can cause the economy to collapse. There are already disturbing signs in the higher frequency data. Consumer confidence has fallen to the record lows seen during the GFC and in March 2020. House prices in Sydney and Melbourne are falling year-on-year, which is likely to accelerate if the RBA delivers a third 50 basis point rise.
Perhaps the biggest concern is the devastating shock to household expectations delivered by the RBA. Martin Place spent all of 2020 and 2021 telling every Australian that fares, except for the guaranteed fares, would be low for a long time.
Through 2020 and much of 2021, Governor Phil Lowe pleaded with consumers, businesses and governments to take advantage of ultra-cheap money, knowing the RBA would protect them from the risk of higher rates.
Australian households responded by increasing their debt-to-disposable income ratio to an unprecedented 187 percent. Home values rose by 37 percent — or to a record 656 percent of disposable income — cementing its role as the largest source of family wealth.
The RBA’s low-yield-for-long-guarantee was explicitly endorsed by its bold interest rate peg, keeping the 2024 Commonwealth bond yield at the same 0.1 percent as the overnight rate. This was to publicly demonstrate that the cash rate would remain at 0.1 percent until at least 2024.
It wasn’t until late last year that the RBA turned down calls for: rate increases in 2022 as implausible† “I’d like to reiterate a point I made a few weeks ago — that is, the latest data and forecasts don’t warrant a cash rate hike in 2022,” was Lowe’s consolation to consumers on Nov. 16.
In just six months, the central bank has transformed from uber-dovish to ultra-hawkish as a result of temporary supply-side inflation that rates will do little to suppress† This started in October 2021 when the RBA suddenly abandoned the rate peg for 2024 within the month, a move that bond manager Charlie Jamieson describes as the most humiliating event a central bank has faced since George Soros knocked Britain’s currency out of the European exchange rate mechanism. early nineties.
You get a sense of how confused the RBA has become due to a bizarre error in the statement released after this week’s board meeting. In the crucial concluding paragraph, the RBA says: “Today’s rise in interest rates is another step in the withdrawal of the extraordinary monetary support put in place to help insure the Australian economy against the worst possible effects of the pandemic.”
But Tuesday’s rate hike did not actually mean the withdrawal of extraordinary monetary support. In October 2019, nearly six months before the pandemic devastated markets, the RBA cut its cash rate from 1.0 percent to 0.75 percent. Last month, the RBA increased its cash rate from 0.35 percent to 0.85 percent.
Accordingly, before its board meeting, the RBA’s cash interest rate was actually higher than it was on March 3, 2020, a day before the RBA decided to cut its 0.75 percent cash rate by just 25 basis points to 0.5 percent. The RBA was promptly forced to rectify that mistake with an unprecedented intra-month meeting 16 days later, on March 20, when it cut the spot rate by another 25 basis points and announced a series of additional monetary policy support measures announced in this column. calling since the end of February†
Australian consumers are now plagued by the fastest rate hikes in a quarter of a century that are crushing disposable income; a massive decline in real wage growth due to a massive, one-off rise in inflation; the specter of a record drop in the value of their greatest asset; the biggest drop in retirement savings since the GFC; and the prospect of higher unemployment as interest rate hikes crush demand.
For years, the RBA has been pilloried for keeping core inflation below the 2-3 percent target and keeping unemployment at an excessively high level that failed to support decent wage growth. As a result, both sides of politics have agreed to an independent inquiry into why the central bank failed to fulfill its mandate.
And yet, at the first sign that the RBA could finally meet its twin legal goals of full employment and price stability, Martin Place risks throwing the baby out with the bathwater.
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