- A resilient economy and low unemployment are expected to drive up inflation in the months ahead.
- The yield on 10-year bonds reached its highest level in 6 years at 2.96%.
- Investors should brace for an RBA interest rate hike this year
RBA pending…….…. for the moment.
The Reserve Bank of Australia (RBA) at its April 5 board meeting decided to leave the official exchange rate unchanged at 0.1%. It has been at this level since November 2020, when the RBA cut the official rate in anticipation of an economic slump resulting from forced closures resulting from the COVID pandemic.
The RBA said it was closely monitoring emerging inflationary pressures to determine the timing of an increase in the official exchange rate. The RBA noted that the disruption in the supply chain has led to shortages of goods and materials, driving up input costs. The Bank is also aware of the inflationary impact of soaring oil prices. Rising house purchase costs and food inflation linked to flood-damaged crops are other factors contributing to the rising inflation outlook. The potential for higher inflation is exacerbated by the tight labor market which could see higher wages, adding further pressure on input costs. ANZ’s latest monthly vacancies survey highlighted job vacancies at their highest level in 13 years. The survey confirms the RBA’s forecast that unemployment will fall below 4% this year and remain low next year. Federal budget documents go further and project that unemployment will remain below 4% for the next 3 years. Australia has not experienced this level of unemployment for 48 years!
The RBA observed in its April 5 statement that periods of low unemployment are correlated with an increase in real wages, which implies wage increases at a rate above the rate of inflation. This prospect heightened the inflationary concerns shared by the RBA board.
The inflation outlook is further complicated by the $8.6 billion cost-of-living assistance package announced in the federal budget, at a time when the economy is already doing well. The cash injection is aimed at low- to middle-income workers, who tend to spend all the cash received.
The Australian economy is strong.
The RBA announcement referred to the strength of the Australian economy following a relaxation of the forced lockdowns introduced at the start of the Omicron variant. The Bank also said household and business balance sheets are strong and the construction order book is supporting job growth.
The RBA has recognized that while inflation is rising in Australia, it is lower than in other countries. According to the RBA, core inflation in Australia is 2.6%, while the headline rate is 3.5%. The RBA will release its revised inflation forecast in May and recently said it expects headline annual inflation to top 4% in the coming months.
The impact of higher interest rates is more easily absorbed by the economy during periods of strong employment and wage growth than during periods of economic weakness. Moderately higher interest rates at this point in the business cycle should support economic growth at close to full employment, without built-in consumer price inflation, which could spiral wages. This implies that a rise in short-term interest rates should have less of a detrimental effect on investment markets and households than if it were not sustained until inflation is entrenched in the economy. economy.
A strong domestic economy has given the RBA reason to react to an expected acceleration in the rate of inflation in the period ahead. The answer will be an increase in interest rates. The question is – when and by how much?
The RBA’s interest rate policy is determined by underlying inflationary expectations and not by the headline inflation rate. Interestingly, the 10-year bond rate is widely regarded as a useful indicator of the direction of future interest rates. This is because bond market participants on both sides of the transaction must agree on a bond price that reflects the direction and amount of the interest rate (yield) payable over the term of the bond. Therefore, trends in long-term bond yields represent the real-time collective wisdom of bond market participants, making changes in long-term bond yields a useful marker that illustrates the direction interest rates may be heading.
Yields on 10-year Australian government bonds have steadily risen in recent months. The 10-year bond yield rose to 2.95% today from 1.67% on 1 January 2022. The message from the Australian bond market is clear: Australian interest rates are set to rise, due to higher inflation.
The forecast for a still-low unemployment rate below 4%, forecasts of strong economic growth and emerging signs of inflation all indicate that the need for historically low interest rates no longer exists.
Evidence suggests that the RBA is likely to announce higher interest rates soon. This could happen in June following the announcement of the RBA’s revised inflation forecast in May.
A major implication of higher interest rates for investors is the impact on stock and property valuations. The historically low interest rate environment has supported equity and real estate valuations for a long time.
In response to a changing interest rate environment, now is a good time for investors to assess their portfolio in terms of resistance to the headwinds likely to accompany a gradual increase in the cost of money over the 12 to 18 coming months.
This Post Market Wrap is presented by Kodari Securities, authored by Michael Kodari, CEO of KOSEC.