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Bond investors expecting Australia to follow New Zealand and South Korea with interest rate hikes in a matter of months may still be too aggressive in their thinking.
New Zealand raised rates Wednesday and flagged more hikes next year, while Korea tightened Thursday. Markets are betting that the Reserve Bank of Australia will raise rates as soon as May, ahead of Governor Philip Lowe's guidance for 2024.
There is a difference that raises the odds against such timing. The RBA wants to see actual figures show a sustainable trend before inflation is set while the RBNZ and the BOK are acting in the traditional method of tightening before inflation.
The test we set is for inflation to be sustainable within the 2 to 3% range, Lowe said at a press conference after the bank's Nov. 2 meeting. We want inflation to get back to 2.5%. Inflation, or the trimmed gauge, tracked by the RBA, was below the midpoint of its range, and was 2.1% in the third quarter.
There is a case for monetary policy in Australia to diverge from near peers and delay the eventual global normalization. The wage outlook will dampen domestic inflation pressures because of the sluggish outlook on government policies and government norms. Australia s labor market will need to run hotter for longer to achieve the wage growth outcomes necessary to sustain inflation within the RBA's 2 3% target band. Lowe won t accept inflation near the bottom of the target because of the repeated use of sustainably suggests that more than one quarter of the data will be needed to convince the governor. Lowe wants inflation to not slow down once the RBA starts to tighten, which is why he said he wants a degree of confidence.
If the central bank wanted to see three quarters of inflation at or above the midpoint, this would suggest the earliest possible move is August 2022, after data for the second quarter is released.
The lack of upward pressure on wages would cause a lot of inflation outcomes, which would be a shock. The labor market has a lack of churn compared to economies like the U.S. that keep Aussie wage growth down. It is also true that much of the local wage-setting process is based on long-term contracts with a 2.5% ceiling, or less in some cases.
According to Hayden Dimes, an economist at Australia New Zealand Banking Group Ltd., our view is that inflation here is unlikely to accelerate to anywhere near the levels seen in places like the U.S. We don't think that wages will reach U.S. levels for some time. The outlook is shared by economists in a Bloomberg survey showing headline CPI is above the 2.5% midpoint this year and staying high in 2022, but then falls back to 2.3% the following year. Wages growth is predicted to barely hit 3% by the year 2023.
Swaps markets are fully pricing in a 15 basis-point hike in May that would take the cash rate to 0.25% from the current record low 0.10%, then two more quarter-point rises - with the chance of a third over the remainder of 2022.
Three-year bond yields have dropped about 30 basis points from a high of 1.28% late last month, suggesting that the most aggressive bets from traders are being scaled back as Lowe maintains a consistent line. The yield on 10 year bonds has slipped by a slightly smaller amount, bringing a modest flattening in the yield curve.
Lowe says wages growth probably needs to be 3% or higher in order to maintain inflation around the 2.5% target midpoint. The RBA's resolve has been tested by markets already and investors proved right when the central bank dropped its yield target at the Nov. 2 policy meeting.
Lowe has not completely ruled out a scenario whereinflation quickens enough to warrant a hike next year. He said last week that the probability of unwinding the decades long decline in wages growth in just six months is very low, it is not zero, but close to zero.
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