Australia, be prepared for higher interest rates

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Are higher interest rates on the way? Stephen Koukoulas intervenes. (Source: Getty)

For the first time in many years, central bankers and global investors are witnessing a significant acceleration in inflation.

Despite the evidence, which shows that inflation is rising to levels well above the target, the reaction of central bankers and investors has so far been subdued.

Some central banks have started to raise interest rates in response to inflationary pressures. Near us, the Reserve Bank of New Zealand hiked rates earlier this month to 0.5%. Others in South America and Eastern Europe have raised interest rates in response to accelerating inflation.

Markets are now openly considering the prospect of rising interest rates in the United States, Eurozone, United Kingdom and Canada, among others, perhaps in the coming months.

Bond markets, which inevitably move well ahead of central banks, have seen yields surge in anticipation of the inflation / rising interest rate dynamic. Movements are relatively contained at this point, but savvy investors look for a further decline in bond yields once the penny drops more broadly as inflation accelerates.

In Australia, the RBA has largely dismissed the pressure, signaling its assessment that inflation will remain low and that it will not be required to hike interest rates until 2024, at the earliest.

RBA Governor Dr Lowe said just two weeks ago.

Stylized photograph of RBA Governor Philip Lowe, who sees the bottom half of his face blurry.

Reserve Bank of Australia Governor Philip Lowe. (Photo by Sam Mooy / Getty Images)

Markets are ignoring this direction, with the start of the interest rate hike cycle starting to be embedded at the end of 2022, just 12 months away and about two years before the RBA believes it will have to move.

Recall that the current official exchange rate is 0.1 percent.

The market forecasts a spot rate of 0.5% by the middle of 2023, 1.0% by the end of 2023 and with further increases until 2024.

If these rate hikes play out broadly as the market suggests, it will be after the RBA ends its bond buying program and the 0.1% yield target for government bonds. dated April 2024.

Such a constructive policy change will only add to the upward momentum in bond yields which will inevitably spill over into mortgage interest rates, especially for fixed rate products.

Next week will see the release of official Consumer Price Index data for the September quarter.

It should show a further rise in inflation that the RBA did not anticipate. Indeed, the annualized increase in core inflation is expected to exceed 2%, a decision that will see the Bank revise its inflation forecasts in the quarterly statement on monetary policy, which is expected to be released in early November.

At its next board meeting on the day of the Melbourne Cup, the RBA must consider whether a spot rate of 0.1%, aggressive bond buying and a target of 0.1% for this which are now 2.5 year government bonds are consistent with the economic and inflationary outlook.

The answer is clearly no.

At this meeting, the RBA would be wise to start marking the end of all such policies and establishing an updated and realistic timeline for what will be an inevitable tightening of monetary policy.

He can easily shrink and then turn off the bond buying program. The same goes for the April 2024 bond target which it can slowly move away from, allowing those returns to be pulled by the market.

In terms of increasing the official cash rate, the RBA must signal to the market that inflationary pressures have been more acute than expected just a few weeks ago and it will follow the lead of other banks. powerhouses stressing the need for a higher interest rate. rate in the coming months.

Not only would this be prudent from an overall inflation management perspective, it could have the advantage of slowing the demand for credit that has fueled the recent spike in house prices.

Such a move would be more powerful than APRA’s recent move to tighten mortgage lending rules.

There are two pre-vacation RBA board meetings, from early December 2021 to early February 2022.

These are the windows for him to be proactive in his political orientations and strategy and to signal, well in advance, that the days of easy money are about to end.

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