Key insights from the week that was.
In a week where first-tier data was largely absent, the focus remained on policy makers, particularly the RBA.
At their July meeting, as widely anticipated, the RBA confirmed that the April 2024 bond would remain the target for Yield Curve Control instead of extending it to the November 2024 bond. The Board also met our expectations for QE by announcing that a weekly purchase target will replace the 5-month $100bn program which is set to end in September. What surprised however was that the RBA decided to taper purchases as the change in program takes effect, with purchases to occur at a $4bn per week pace instead of $5bn, the effective weekly pace of the current program. The scale of purchases will be next assessed in November 2021. We believe that purchases will continue beyond this date to mid-2022, albeit with repeated reductions in scale.
Our forecast that RBA rate hikes will come in 2023 rather than 2024 is supported by the above developments as well as the slight change in language in the Governor’s decision statement on the conditions for rate hikes being met, with June’s “This is unlikely to be until 2024 at the earliest” replaced by “The Bank’s central scenario for the economy is that this condition will not be met before 2024”. This change highlights both the greater momentum seen to date as well as upside risks to the RBA’s central scenario.
Still, in the subsequent press conference and Thursday’s speech on the labour market, Governor Lowe made clear the bar to raise rates is high. As discussed by Westpac Chief Economist Bill Evans, in the press conference the RBA Governor highlighted that, to raise rates, inflation must be sustainably in the 2-3%yr target range. To achieve this, the RBA see wage growth above 3.0%yr as necessary. And, for that to occur, full employment needs to be achieved and held – this equates to an unemployment rate in the “low 4’s”.
Westpac expects an unemployment rate of 4% by mid-2022 and inflation in the target range from that point on. To us then, the conditions for rate increases will be met by 2023.
Our New Zealand team was also focused on the monetary policy outlook this week, revising their expectations for the RBNZ to include rate hikes from November this year. The cost and labour pressures faced by NZ because of global supply disruptions and closed borders are well known; but there is now growing evidence of strong demand coming through, increasing the risk of more enduring price pressures.
Further afield, we also received guidance this week from the US FOMC and Europe’s ECB Governing Council.
In the minutes of the June FOMC meeting was clear evidence of growing confidence in the immediate outlook for growth and the labour market. That perceived strength has also clearly fostered a belief that underlying inflation will strengthen sustainably to target, justifying lift-off for rates, albeit not until 2023 on the Committee’s median expectation.
Westpac expects FOMC rate hikes to come earlier, beginning in December 2022. However, unlike prior cycles, we believe this cycle will end with the fed funds rate more-or-less at its neutral level, which we hold to be 1.625%.
This comparatively low endpoint coupled with the length of the cycle will keep term interest rates in check. As outlined by Chief Economist Bill Evans, we now see both the US and Australian 10-year yields peaking at 2.3% halfway through the FOMC/ RBA tightening cycles. A positive spread to cash will be seen thereafter for the 10-year yield in each jurisdiction, with both the US and Australian economies comfortably growing at trend and inflation at target from 2024.
This week also saw the release of the ECB’s long-awaited policy review. The Governing Council did not quite go as far as the market had hoped with their inflation target, moving to a symmetric 2.0%yr target rather than a FOMC-inspired ‘average 2.0%yr’ benchmark. But this is still more accommodative than the current ‘close to, but below, 2.0%yr’ threshold.
While subtle, these differences in policy objectives amongst key central banks are likely to materially impact their decision making and hence FX markets as rate hike cycles begin from 2023. This is a topic we take up in the Global FX page of our July Market Outlook, to be released later today.