Why hiking rates now, and quickly, isn’t the answer

RESERVE Bank of Australia (RBA) governor Philip Lowe (picture) is a history buff. He reckons he has a chance to drive the jobless rate to the low levels of the 1970s without the inflation spiral that gave the decade a bad name.

Lowe’s ambition rests on the premise that he can succeed where other central bankers have failed, by allowing the recovery to strengthen without getting unbearably hot.

Data on Monday showed just how complicated this task will be, with retail sales blowing past forecasts to notch a record 8.2% gain in the final three months of last year. While inflation has jumped unexpectedly in the past two quarters, it hasn’t yet pierced the upper end of the central bank’s 2% to 3% target.

Lowe says he wants to see levels “sustainably” within the range before lifting borrowing costs, though he hasn’t defined what that means.

The RBA kept its official rate at 0.1% on Feb 1 and, a few days later, lifted its forecasts for jobs and inflation. The bank counselled patience on rates while, in a nod to the accelerating economy, announced it would wrap up the bond-buying programme it introduced at the peak of the pandemic.

The signalling here is delicate. Concluding quantitative easing (QE) doesn’t mean an interest-rate hike is imminent, Lowe stressed.

Success in containing inflation — the pace of price increases is well above target in the US and UK — will mean the RBA is vindicated in holding off on rate hikes, at least for a while.

Failure will mean borrowing costs probably climb faster and further than might otherwise be the case. Many economists foresee rates rising in the second half of the year (2H22).

Lowe’s apparent lack of urgency has him characterised as a lonely dove in a world of hawks. This depiction is incomplete and dismisses how far the RBA’s rhetoric has evolved in recent months.

The bank concedes rates may rise this year and is scheduled to make the final bond purchases of its quantitative easing programme today.

It was only a few months ago that officials were guiding investors toward a 2024 liftoff.

That’s quite a shift in a fairly short time. If rates go up in the second half of the year, the RBA won’t be too far behind the US Federal Reserve (Fed), which is all but certain to lift the benchmark federal funds rate in March.

That would be the Fed’s first nudge higher since 2018. Such a timetable would have the RBA running ahead of the European Central Bank (ECB), which itself recently executed a “hawkish pivot”.

If ECB president Christine Lagarde, who last week declined to rule out a hike this year, is seen as a hawk, why not Lowe? (The eurozone and Japan were supposed to be the places that would never kick the easy money habit.)

Depictions of Lowe as a dove also downplay his awareness of what’s at stake.

“Australia is within sight of a historic milestone — having the national unemployment rate below 4%,” he told the National Press Club last week. “This is important because low unemployment brings with it very real economic and social benefits for many Australians and their communities.”

A misstep would be potentially perilous. Lurking in the background, both major Australian political parties want a review of the RBA after national elections, likely to be held in May.

Change is coming for the bank regardless of whether the centre-right coalition of Prime Minister Scott Morrison stays in power or the Labour Opposition is victorious.

Potentially up for grabs is the structure of the bank’s board, Treasury’s tradition of selecting RBA leaders from within the institution, and the level of transparency about the bank’s deliberations.

A sharp move higher in rates and, possibly, a recession would be unfortunate timing.

But time isn’t working entirely against the RBA, either. Though an arms race in global interest rate projections has gathered pace in recent weeks, there’s a limit to how high borrowing costs will go.

“While markets have priced in ‘more hawkish’ central banks, they still expect these hiking cycles to end at historically low levels,” Morgan Stanley strategist Andrew Sheets wrote in a note on Sunday.

The firm’s economists predict inflation will slow in the 2H22 after picking up in the January-to-June period. “There is a lot of time on the game clock.”

If this assessment is correct, Lowe will be hiking — or considering it — in a friendlier environment than exists now.

Rather than being behind the curve and having to do more, it’s conceivable he will have built a stronger foundation for the economy and have to hike less.

Give Lowe his due for flexibility. He took the RBA to near-zero rates and then to QE, a prospect serious people once scoffed at. So-called unconventional policy was seen as something for the Northern Hemisphere, not the country that hadn’t suffered a recession in three decades and that discovered a magic formula for prosperity.

If Lowe is behind the pack in hiking, it will likely be by a matter of months. He may be a dove, but he’s got a hawk’s eye. — Bloomberg


This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.