What future for the RBA?
Three-month Australian banknote futures have an implied yield of around 1.3%, in contrast to the current overnight cash rate of around 0.05% and the target for cash rate of 0.1%. Thus, given the development of a 3-month term premium, the markets seem to be expecting more than 4 hikes from the Reserve Bank of Australia (RBA) this year.
But such expectations of a sharp rise in rates remain in stark contrast to the guidance still given by the RBA. While this has been successively toned down from its earlier insistence of “nothing until 2024”, the language remains very dovish, with the latest statement accompanying the Dec. 7 no-change decision noting that for rates to be changed “the market (would need) tight enough to generate substantially higher wage growth than it is now. This will likely take time and the Board is willing to be patient.
Since that statement, we’ve seen Australia’s unemployment rate drop sharply to 4.2%, which ticks one of the boxes required for the RBA to change its mind. Another is the action of other central banks. And with the US FOMC starting its 2-day meeting today ahead of a likely decision to immediately cease QE activities and signal a rate hike in March, that would seem to tick another box.
Another concern for the RBA is the functioning of the Australian government bond market. Yields on 2-year Australian government bonds are up around 30bps from the end of last year to around 90bps, and 10-year government bonds are also up around 30bps to around 1.95% now. It’s similar, albeit slightly more than what we’ve seen in comparable US Treasuries.
Wages are about the only thing holding the RBA back from taking a more active policy approach to the current economic conditions. The 4Q21 wage price index is published on February 23. This is long after the RBA meeting on February 1 and probably won’t feature much in the decision-making at that meeting, but it could be a staple for later meetings.
Therefore, we expect the RBA to set an end date for its asset purchases at the February meeting – although it may not immediately cease its purchases. However, we expect them not to drastically change their rate stance, leaving it dependent on the evolution of higher wage inflation. This sets us up for a change in policy direction at the next meeting on March 1 if the perceptible rate of price-wage inflation rises. A level of wage growth of 3.5% would likely be enough to precipitate imminent policy action, while increases below that rate could still allow the RBA to remain on hold, albeit with a much less dovish tilt.