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6 May 2022 - Hedge Clippings |06 May 2022



Hedge Clippings | Friday, 06 May 2022


This week the RBA governor Philip Lowe abandoned his previous expectation made in March 2021, namely that for inflation to be sustainably in the 2-3% range, then wages growth (then 1.4% and the lowest on record) would need to be sustainably above 3%. As he wasn't expecting that to occur any time soon he stated "the cash rate is very likely to remain at its current level until at least 2024".

The RBA's main concern at that time was that inflation was too low. The rest, as they say, is history. This week the RBA lifted official rates by 0.25% to 0.35%, and the big four banks' mortgage rates followed suit.

One of the problems facing economists and their economic forecasting is that all the models rely on historical back-testing, and they're generally not so good when it comes to expecting the unexpected. In this case, wages growth has remained subdued (as per the RBA's expectations) in spite of a tight labour market and unemployment running at just 4%. However, inflation - at 5.1% over the 12 months to March - has jumped out of the blocks, thanks mainly to external and generally one-off factors.

Back to March 2021, and RBA Governor Philip Lowe expected these one-off factors - which he described as "transitory" - to be mainly pandemic or drought related, and he also stated that the RBA board would "look through" these when setting monetary policy.

The best laid plans etc., etc.  To be fair (as Scomo is keen to point out), this is not unique to Australia, and no one to our knowledge anticipated Putin's invasion of Ukraine and its effect on oil and energy prices. Inflation in both the US (+8.5%), the UK (+7.0%), and the Euro area (+7.4%) are all higher than Australia's. As a result, the US Fed raised rates by 0.5% after lifting them by 0.25% in March, and overnight the Bank of England raised theirs by 0.25% to 1.0%.

US equity markets, which have been anticipating rate rises, but maybe not by 50 bps, took fright, and the ASX has followed suit. Cryptocurrencies led by Bitcoin, supposedly uncorrelated to equities, dropped over 8%.

However, in Australia the main concern seems to be the overheated residential property market, which just goes to show that you can't please all the people all of the time. Thanks to 10 years of falling and ultra low interest rates, property prices have skyrocketed, benefiting some, and locking others out of the market. Higher rates will, according to some forecasters such as Christopher Joye in today's AFR, cause house prices "to correct by up to 25%". That should cause some grief for those recently joining the market, but please future new entrants.

While our obsession with property prices will remain, the greatest issue from here is the balancing act the RBA will have managing the economy by trying to tame inflation (as above, largely caused by global "transitory" issues and events) using tighter monetary policy, while not stalling the economy and, thereby increasing unemployment as a result. Labour's shadow treasurer Jim Chalmers wants higher real wages (as does the RBA), but that's just going to feed into higher "non transitory" inflation.

A balancing act indeed - and if history tells us anything, it's that the RBA is generally behind the curve when it comes to timing.

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