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Printed: 02 December 2023 3:47 AM


9 Dec 2022 - Hedge Clippings |09 December 2022



Hedge Clippings | Friday, 09 December 2022

Let's take a look at interest rates - and the inflation that drives them:

To the surprise of few, but no doubt to the dismay of many, the RBA lifted rates for the eighth consecutive month this week, taking them to a 10 year high of 3.15%. In real terms not a great increase, and as one who remembers rates around 18% (so long ago they're not even included in the RBA's chart below) 3.5% - 4.0% by mid next year doesn't seem horrific.

(As a slight aside, and at the risk of being accused of being pedantic (again), the above graph sourced from the RBA's website also looks a little out of date, still showing last month's rate of 2.85%.)

Unless of course, you're one of the unfortunate ones who listened to Philip Lowe's statement in February/March 2021 that "The central scenario remains that the conditions for a lift in the cash rate will not be met until 2024." And in case anyone thought that was a one off, the RBA's view was held or repeated throughout 2021 and well into 2022.

Let's follow some of the subsequent "non" advice from Australia's most senior banker:

In November 2021, he conceded "genuine uncertainty as to the timing of future adjustments in the cash rate" and that a pre-2024 rate rise was "possible". He continued to dismiss, however, the fact that the market was pricing in a series of rate rises in 2022 as "a complete overreaction" and maintained it was "still entirely possible that the cash rate will remain at its current level until 2024″.

In February this year (10 months is a long time in the real world) following its first board meeting of the year, the RBA board kept the official cash rate at a record low of 0.1 per cent. As a slight hint - probably lost on the average punter taking out a mortgage, however, it did terminate it $350 billion pandemic bond buying program, citing significant improvements in the jobless rate and the broader strength of the economy.

The RBA also up its inflation forecasts following a surprisingly strong December 2021 quarter, at that time expecting underlying inflation to peak at 3.25 per cent later in 2022, before moderating back to 2.75% in 2023. But despite currently being at the mid-point of the RBA's 2 to 3 per cent target band and set to push higher for the first time in almost a decade, Governor Philip Lowe said the conditions for rate rises were not yet in place: "While inflation has picked up, it is too early to conclude it is sustainably within the target band.".

Lowe was at odds with the market, which had factored in 4 rate hikes for 2022, but he wasn't the only senior economist to misjudge inflation, and therefore the upward path of interest rates: "We see the cash rate at 0.75 per cent by November 2022, rising to 2 per cent by the end of 2023," ANZ head of Australian economics David Plank said. Ooops!

To be fair every other central bank has misjudged inflation, no doubt in large part because the world as a whole didn't envisage Putin's invasion of Ukraine - now also considered as misjudged by everyone except Putin himself, except perhaps in his most private moments. Wouldn't hindsight be a wonderful gift to have?


So inflation is now a fact, although as yet not as severe in Australia as in the US or Europe, and particularly the UK, where CPI rose to 11.1% as of October.

Meanwhile, the UK has its own set of problems, with industrial action in key sections of the economy left, right and centre leading up to and including Christmas. At least they have the distraction of the Harry and Megan show.

Inflation, Interest Rates, and the R word:

The fact is everyone is now aware of inflation. What follows inflation is higher interest rates. What follows higher interest rates is an economic slowdown designed to tame inflation. The risk when engineering a slowdown to soft landing is overshooting and creating a recession, which seems pretty inevitable in the US, UK, and Europe but less certain here. Certainly, Australian consumers are worried about a recession according to Google:

Australia has a couple of distinct economic advantages compared with other "not so lucky" countries: In spite of China's best efforts, and their COVID induced lockdown, our mineral and agricultural sectors have remained buoyant. While there's some argy-bargy going on between the Federal government and the States (NSW and Queensland in particular) over energy price caps, shortages aren't the issue, and renewable and alternative energy sources are increasingly mainstream.

So where to from here?

We have discussed before the importance of the last paragraph - and sometimes even the last sentence - of the RBA's monthly statement, so heed the following carefully from last Tuesday:

"The Board expects to increase interest rates further over the period ahead, but it is not on a pre-set course. It is closely monitoring the global economy, household spending, and wage and price-setting behaviour. The size and timing of future interest rate increases will continue to be determined by the incoming data and the Board's assessment of the outlook for inflation and the labour market. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.


No mention of creating or avoiding a recession, just what's required to return inflation to the 2-3% target range. Hopefully, Philip Lowe's reading of the economic tea-leaves improves over his Christmas holiday.

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