Fresh Out Of Patience, Australia’s Uber-Dove Shocks Markets

It wasn’t so long ago when RBA governor Philip Lowe was a “patient” man, predisposed to insisting that rates in Australia would likely remain near record lows until 2024. Australia was different, he’d say.

The market never believed him. I’ve been over this before. But it bears repeating, because on Tuesday, the bank hiked rates for a second straight meeting, only this time, by 50bps (figure below). It was the largest increase in more than two decades.

Some were taken aback. Economists expected a hike, and a larger increment was by no means off the table, especially in the market’s eyes. So, this wasn’t a “shock” in the Chicxulub impactor sense. But just 10% of economists predicted it.

If Lowe was out of policy patience last month, now he’s downright anxious.

“Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected,” he said Tuesday, blaming “global factors, including COVID-related disruptions to supply chains and the war in Ukraine” for most, but not all, of the inflation impulse. “Domestic factors are playing a role too, with capacity constraints in some sectors and the tight labor market contributing to the upward pressure on prices,” Lowe added. “The floods earlier this year have also affected some prices.”

A pandemic, a war, labor shortages and floods. Sounds biblical.

Lowe conceded that the outlook has worsened compared to… well, compared to just a few weeks ago, actually. “Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near-term, inflation is likely to be higher than was expected a month ago,” Lowe remarked, between delivering the obligatory central banker nod to the likelihood that price pressures will eventually abate and conveniently settle at levels consistent with their mandates and targets. The figure (below) is a snapshot.

The Australian economy grew faster than expected in the first quarter, data out last week showed. The figures were bolstered by inventories, but household spending rose, wages jumped 5.5% YoY and the overall pace of growth, distorted or not, was much quicker than the pre-COVID average. The data prompted swaps to price a 40bps hike at Tuesday’s meeting.

Lowe mentioned the risk to consumer spending, and also flagged the housing market, a source of perpetual consternation for the country’s indebted households. May’s rate hike was the first in more than a decade. Apparently, the prolonged nature of the easing cycle means more than a million home buyers are experiencing their first ever rate hikes.

Some have suggested it’s not feasible for the RBA to meet market expectations. “Market pricing… would likely crash the housing market and cause a recession,” George Tharenou, chief economist for Australia at UBS, said last month. Westpac on Tuesday said it’ll increase home loan variable interest rates by 0.50% for new and existing customers from June 21.

New Zealand, which hiked rates by 50bps for a second straight meeting last month, is likewise pondering the impact of higher rates on a housing bubble. A similar dynamic exists in Canada, where policymakers leaned in last week.

“One source of uncertainty about the economic outlook is how household spending evolves, given the increasing pressure on Australian households’ budgets from higher inflation,” Lowe went on to say. “Housing prices have declined in some markets over recent months but remain more than 25% higher than prior to the pandemic, supporting household wealth and spending.”

He telegraphed additional hikes “over the months ahead.” ANZ sees 25bps in July followed by another 50bps hike in August. “One or two more rate hikes over the remainder of 2022 are possible if the data remain ‘resilient’ despite all the various pressures facing households,” the bank’s David Plank wrote. “This will get the cash rate to around the bottom of the 2-3% range for neutral.”

Long story short: New Prime Minister Anthony Albanese is staring at a series of rate hikes with the potential to destabilize households and, possibly, the economy. An ANZ gauge of household sentiment fell to the lowest levels in 22 months in data released Monday.

Tuesday’s decision was a bear flattener for the Aussie curve. The market is pretty clearly concerned about the drag on growth from a suddenly hawkish dove. Three-year yields jumped some 20bps, while 10-year yields rose just 5bps. Growth concerns and the possibility that policymakers won’t be able to deliver on market expectations without undermining the economy, appeared to cap gains for the Aussie.

Recall that the RBA was forced to abandon its yield-curve control regime late last year when yields on the target note rose to eight times the cap (herehere and, for the coup de grâce, here). But Lowe steadfastly refused to countenance the idea of aggressive rate hikes to combat inflation. In fact, he was reluctant to entertain any hikes at all in the near-term.

On Tuesday, by contrast, he said the RBA is “committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”

In a note, SocGen’s Suktae Oh wrote that “concerns over consumption and the housing market could explain” why the RBA is “hesitant towards outright tightening.” “Policymakers have continually referred to the current rate-hike cycle as ‘a process of normalizing interest rates’,” Oh said, adding that the RBA has “never used the word ‘tightening.'”

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