Despite a near zero per cent chance of any decision to increase the official cash rate, Tuesday’s meeting of the Reserve Bank board is set to be truly historic.
Well, for one, we know the bank is sure to announce the end of its extraordinary program of buying government bonds. It’s not clear if the bank will simply cease buying bonds altogether in February, or begin a slower “tapering” of the current pace of purchases of $4 billion a week.
All eyes are on the Reserve Bank and interest rates. Credit:Louie Douvis
This historic program means our central bank today owns a whopping third of all Australian government bonds on issue. The goal, of course, was to put downward pressure on borrowing costs in wholesale markets.
And it worked, for a time. But creeping wholesale borrowing costs are a tide that can’t be held back forever, and it’s time to stop trying. And that’s a good thing – a sign that around the world, and at home, economies are picking themselves up off the COVID floor.
Economies are picking up after COVID lockdowns.Credit:Wayne Taylor
The ending of the program will mark another step by the Reserve towards unhooking the Australian economy from the multiple life support mechanisms it unleashed during COVID.
The other main support, of course, was the decision to cut the official cash rate to a historic low of 0.1 per cent.
Since that original decision, made during some of the darkest days of COVID, Reserve Bank governor Philip Lowe has remained adamant he does not see the pre-conditions for a rate hike forming until 2024.
Over the summer break, however, most market economists have come to expect increases to the official cash rate at some point in 2022. They will be closely watching for any changes to Lowe’s “messaging” on the timing of future hikes in his Tuesday statement.
As recently as November last year, Lowe himself was clearly against 2022 hikes: “The latest data and forecasts do not warrant an increase in the cash rate in 2022. The economy and inflation would have to turn out very differently from our central scenario for the board to consider an increase in interest rates next year.”
Over summer, however, the labour market has shown surprising strength and measures of underlying inflation in consumer prices have also surprised, surging right into the middle of the Reserve Bank’s target band of 2 to 3 per cent.
So, are these inflation pressures a blip, or part of a newly entrenched trend? That is the question.
Lowe has consistently said he wants to be sure inflation is “sustainably” within the band before he will lift rates.
Market economists clearly believe the inflation pressure is on – but then, market economists spend a lot of time watching international trends, where inflation is raging and rates are rising.
But Lowe’s focus is firmly closer to home and even before COVID, Australia’s economy seemed more inflation-proof than most. Since Lowe took the helm in September 2016, there have been 22 quarterly inflation reports. Just two – the latest two – have shown headline inflation above the 3 per cent band. Four have been within the target range, and 16 below.
Indeed, on the key performance indicator of all Reserve Bank governors – keeping inflation between 2 and 3 per cent – Lowe has had far more misses than wins.
During that time, however, Lowe has been able to express a very clear vision of what it will take for Australian inflation to return sustainably to his target band.
The missing link, according to Lowe, is pay rises. Of the 21 official wages reports since Lowe took the helm, nine have shown wage gains with a “1” per cent in front. The remainder have had a “2″ per cent in front. None have had a “3” per cent in front.
And yet, as Lowe said in November last year: “It is likely that wages will need to be growing at 3 point something per cent to sustain inflation around the middle of the target band.”
Why are wage rises necessary to fuel inflation? Well, only permanent pay rises reliably put the money in the pockets of workers they need to sustainably bid up prices for goods and services.
And for some time now, Aussie workers have had much less success than their international counterparts in securing wage rises with a “3” in front.
A key factor, according to Lowe, has been a stubbornly “strong cost-control mindset” among Australian employers. Another factor is the irregularity with which most Australians have their pay adjusted – annually if on awards, and every two years or so if on collective agreements.
Given Lowe’s laser-like focus on wages growth, the key question, then, for the timing of future interest rate hikes is surely this: what is the minimum standard of proof Lowe will want to see before he is convinced his yardstick of 3 per cent wage rises is going to happen?
Wages rose just 2.2 per cent in the September quarter, according to the latest quarterly wages report. The next reports are due in February, May and then August.
So, will Lowe stick to his guns and wait until he sees a wage report with a “3” per cent growth rate before launching rates “lift off”? Or, would quarterly increases of 0.75 per cent suffice? If so, how many quarterly reports like that would he need to see before he’s convinced wage pressures are significant enough to feed into sustainably higher demand for goods and services?
Lowe will address the National Press Club on Wednesday in Sydney. It’s going to be quite the show.
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