It looks as though central banks have decided that downshifting to smaller rate hike increments is the best way to ensure they can keep hiking rates as necessary in the event inflation remains recalcitrant.
The RBA on Tuesday hiked by 25bps for the second straight meeting (figure below), confirming the new cadence.
The bank’s smaller-than-expected move last month is now viewed, in hindsight, as the beginning of a coordinated “mini-pivot.” Weeks later, the Bank of Canada surprised with a smaller-than-expected hike and the ECB last week dropped key hawkish language from the policy statement after delivering a second consecutive 75bps move.
“The minutes of the RBA’s October meeting indicated the decision between a 25bps and 50bps hike was evenly balanced but our sense on reading the November statement does not suggest today’s decision was as even a contest as the October decision,” TD’s senior Asia Pac rates strategist Prashant Newnaha said. “On balance, today’s statement read a touch dovish compared with our initial expectations.”
Although the RBA spent six paragraphs Tuesday discussing “too high” inflation, a “very tight” labor market and an economy that’s growing “solidly,” the only passage that mattered was this one:
The Board recognizes that monetary policy operates with a lag and that the full effect of the increase in interest rates is yet to be felt in mortgage payments. Higher interest rates and higher inflation are putting pressure on the budgets of many households. Consumer confidence has also fallen and housing prices have been declining following the earlier large increases.
In the very next breath, the RBA said plentiful jobs, higher wages and “large financial buffers” are “working in the other direction,” but markets are focused on the extent to which policymakers are inclined to mention “long and variable lags.” Any mention of the delay between higher rates and the impact on the economy is taken as dovish.
Do note that the confirmation of the less aggressive hike pace came despite a very hot read on Q3 inflation, which some suggested might compel the bank to shift back up to 50bps moves.
Inflation was the highest in 32 years last quarter, data out last week showed (figure below). The trimmed-mean gauge was the highest in series history (it was inaugurated in 2003).
The RBA said Tuesday it expects inflation to peak at 8% this year, and decelerate to 4.75% in 2023.
“The RBA’s decision to deliver a 25bps hike even after a significant overshoot on Q3 CPI means the hurdle to the bank hiking in 50bps clips is very high,” TD’s Newnaha went on to write. “Not that we were entertaining 50bps in our forecast path, but today’s action and tone of the statement provide further confirmation that 50bps hikes are off the cards.”
ANZ’s David Plank said Tuesday’s statement suggested “the RBA is now prepared to tolerate inflation above target for a longer period.”
Philip Lowe emphasized that officials are “resolute” in their determination to bring inflation down and will “do what’s necessary” in that regard, but the statement described the tightening delivered since May as “material.”
Later, during a dinner address, Lowe called inflation “evil” and said it can’t be allowed to persist. He also said the path to a soft landing is “narrow” and that “developments elsewhere in the world” could knock the bank off course.
Domestic developments could likewise derail Lowe. CoreLogic’s national Home Value Index fell a sixth consecutive month in October, data out Tuesday showed. “Despite the easing in the pace of decline, with Australian borrowers facing the double whammy of further interest rate hikes along with persistently high and rising inflation, there is a genuine risk we could see the rate of decline re-accelerate as interest rates rise further and household balance sheets become more thinly stretched,” Tim Lawless, CoreLogic’s Research Director, remarked. Prices in Sydney have fallen for nine months in a row.
Lowe on Tuesday explained the rationale for the front-loaded rate hikes that’ve piled pressure on borrowers — and also the rationale for moving away from front-loading:
We moved in large half percentage point increments for four months, but at this and the previous meeting, we returned to more standard quarter percentage point increases. The earlier large increases were required to move interest rates quickly away from their pandemic levels to address the rapidly emerging inflation problem. But as interest rates moved back to more normal levels, the Board judged that it is appropriate to move at a slower pace while we assessed the data, the economic outlook and the impact of the rate rises to date. We are conscious that interest rates have been increased by a large amount in a very short period of time and that higher interest rates affect the economy with a lag. If we are to stay on that narrow path, we need to strike the right balance between doing too much and too little.
Again, it’s obvious that central banks are now inclined to move away from front-loading.
There’s a sense in which this is a non-story. If “front-loading” means anything, it’s that faster rate hikes “now” means slower rate hikes, or a pause, later. If the pace of hikes established during the front-loading phase persists for the entire cycle, then it wasn’t “front-loading,” was it? Eventually the pace has to slow. And eventually the hikes have to stop. If not, rates will be 50% by 2030.
That said, this is absolutely a story in the sense that markets were becoming palpably concerned that central banks were going to wait to see (more) evidence of “breakage” before the step-down. That no longer appears to be the case. The deescalation is here, but with a twist. Policymakers see a trade off. Stepping down now cuts the left-tail risk of severe recession. As long as there’s no severe downturn, hiking in bite-sized steps to control inflation will still be possible as the economy decelerates.
A key consideration is that it’s probably not a good idea to extrapolate a lower terminal rate from a coordinated dial-down in the pace of rate hikes. In fact, it could very well be that the less aggressive pace opens the door to a higher terminal rate if the avoidance of a severe recession gives central banks more runaway to keep ratcheting rates higher in more palatable increments.
The RBA’s rapid-fire rate hikes this year were the culmination of a stunning about-face. The bank’s Tuesday hike came on the one-year anniversary of yield-curve control’s demise in Australia. The RBA was forced to abandon the short-lived experiment when yields on the target note rose to eight times the cap.
In the aftermath of the debacle, 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, repeatedly insisting rates would likely remain at record lows until 2024. The market never believed him. Now here we are, a year and 285bps later.
“We are not on a pre-set path,” Lowe said Tuesday. “If we need to step up to larger increases again to secure the return of inflation to target, we will do that. Similarly, if the situation requires us to hold steady for a while, we will do that.”
You mean hiking too fast and by too much might not be such a good idea? Amazing! Who would have thought? The FOMC will throw the 75 out there because they pretty much told the market they would. After that who knows? A 50? A 25? A pause? Of course they will use inflation numbers and employment- both right now are lagging indicators. Market indicators for now will tell you that the economy is slowing and inflation rates (for now at least) have peaked. If the Fed does slow down or stop, which they should, they will now be driving the car looking out the front window not the rear view mirror. It is well to keep in mind that raising rates by 25 is not easing, it is tightening at a slower pace. They should also bail on shrinking the balance sheet. That is an idea straight out of a dead economists playbook and has no utility whatsoever.
There is no chance of 25 or “a pause” in December from the Fed. No chance. If they paused in December, stocks would take off into the stratosphere, reals would tumble, the dollar could pretty easily fall 5% and the combined effect would be a financial conditions easing impulse double the size of that seen following the July FOMC meeting. I noticed you never responded to my comment when I showed you how the Fed’s 75bps hike in July was followed by a large easing in financial conditions. Presumably that lack of response reflected the difficulty in arguing with data and a chart.
Also, what “dead economists” are you talking about? Was there a period in history where large-scale asset purchases were tried across economies, and the resultant large balance sheets unwound? And was that time period so long ago that the people who presided over it are all dead? If so, what was that period and who are those economists?
I agree there is no chance for 25 or pause in December, but for the first time I’m inclined to bet that 50 is the most likely path for the last meeting of 2022. I have a hard time believing these other CBs are stepping down their pace of hiking without at least some hint from the Fed that the big dog plans to follow course, otherwise these other policy makers risk getting their economies and currencies torched, interesting developments indeed.
This week’s Economist has an interesting piece which looks at the records of the early movers tightening movers. Interesting in light of the near constant barrage of “the Fed waited too long to tighten” narrative. (Attention Summers & El Erian.)
Guess what? It doesn’t seem to have helped anything in those nations that did tighten the nooses sooner.
Or anyone who lives there, not that collateral damage matters to career bureaucrats. Their comfortable jobs, pensions and healthcare are secured for life.
Sorry, but it’s time to further rethink our reliance on tried-and-rarely true economic models. Give the Fed credit for trying to do that.
Of course they waited too long. Unless you want to argue they didn’t have to hike at all, then the longer they waited, the further behind the curve they were in consumers’ and the market’s estimation, which is all that matters.
Nobody seriously believes these rate hikes (let alone the timing of them) were the deciding factor in whether or not inflation would’ve accelerated in 2021. The inflation acceleration was a foregone conclusion given how the pandemic played out (inclusive of successful vaccines, fiscal stimulus and the impact of supply chain disruptions) and it was made immeasurably worse by the Ukraine war.
The problem here is that monetary policy has some role to play — large, small or in-between. Given that, sitting around while inflation accelerates to twice and then three times a target that you self-identified with your congressional mandate, means you waited too long.
My contention continues to be that inflation, as it’s currently manifesting, is beyond anyone’s capacity to rein in, unless we want to talk about stopping the wars and coming together as a global community to solve existential problems, like food insecurity, the energy quandary and so on. We’re plainly not going to do that. Because we’d rather kill each other over nothing and pretend that defending sundry -isms is more important than ensuring the survival of the species.
Absent a global “come together” moment, and assuming we want to insist that inflation isn’t something that’s totally beyond our control, then somebody has to take responsibility when it’s out of control. As Summers put it, in remarks to The New Yorker, policymakers’ job is to balance supply and demand. When you get scorching-hot inflation, it means somebody, somewhere failed.
If not, then inflation is nobody’s responsibility and it’s stochastic, in which case we should just give up.
The mistake was not taking action. The mistake was the signaling from a couple of Fed loudmouths and an ex-official which took away any and all flexibility.
That brings to mind the stories of invaders burning the ships which carried their troops to the battlefield: “In the year 1519, Hernán Cortés arrived in the New World with six hundred men and, upon arrival, made history by destroying his ships. This sent a clear message to his men: There is no turning back.”
This article prompts my implied “operation” of the economy to meet end goals against variable dynamic inputs and reminds me of operating large scale biological reactors where one tries to keep the bugs happy, except there the bugs have no influence on policy, and no clue that man is their god. In the setting where the bug population gets out of whack from ambient unregulated inputs, the course that allows for aggressive adjustments on the front end, and bite sized control on the back end based on routine monitoring, can occur within well (professionally) managed systems. The inputs can never be controlled therefore population dynamics are still at play however they are just bugs too fat or too skinny be that as it may. Mismanaged operation of the system and or unanticipated/unprecedented inputs can bring about wild swings, and ultimately foul the output matrix with the potential to contaminate and perhaps kill on contact; a recession.
I have little faith for man as God but i wish them luck.
In a way, it feels like we are approaching the stage where central banks say, “Here, we’ve done our part on demand destruction, so we gotta slow down or else take the blame for the next depression (after taking the blame for inflation),”. As the notion of “rate hikes don’t solve supply-driven inflation” seeps into the collective consciousness, there will be increasing calls for industrial/fiscal approach to address the expected, structurally higher inflation for the next decade(s).
If so, what’s the implication? My guess: median FFR of ~3.5% (& 10yr UST of ~4.5%), more stable FFR compared to past 2 decades, policy innovation to replace the QE/QT mechanism (and as complement to the blunt FFR tool) in order to cap sovy bond yields/ facilitate fiscal-driven, supply-side policies.
Side note, i tried to minimize recency bias when thinking about the future. Recall that during the low-inflation era, frequently cited factors include globalization/supply chain, which is now reversed. But certain disinflationary factors still remain: technology, demographics (though now some consider it an inflationary factor through labor market), higher debts… Just wondering what could potentially make the “higher-inflation-for-longer” view, that seems so consensus now, look so very wrong a few years down the road…
“Just wondering what could potentially make the “higher-inflation-for-longer” view, that seems so consensus now, look so very wrong a few years down the road…”
Excellent thought.