Mortgage-holders and other borrowers may face higher repayment costs sooner than expected after the Reserve Bank of Australia declared it would stop buying government debt from 10 February and lifted its forecast for underlying inflation next year while cutting its jobless rate projection.
The steps, disclosed after the RBA’s first meeting of 2022 on Tuesday, suggest the central bank deems it can pare support for an Australian economy already bolstered by record budget deficits even with disruptions from the Omicron Covid variant.
The RBA left its cash rate unchanged at the record low 0.1% annual rate it has been since November 2021. The RBA governor, Philip Lowe, stressed the end of its quantitative easing program of buying up debt to drive long-term interest rates lower did not signal the cash rate would soon be raised.
“Ceasing purchases under the bond purchase program does not imply a near-term increase in interest rates,” Lowe said.
“As the Board has stated previously, it will not increase the cash rate until actual inflation is sustainably within the 2 to 3% target range,” he said. “While inflation has picked up, it is too early to conclude that it is sustainably within the target band.”
Still, economists will note the recent stronger-than-expected economic activity at the end of 2021 as New South Wales and Victoria emerged from Covid lockdowns has prompted the RBA to elevate its inflation projection.
Underlying inflation that the bank uses to set rates is set to reach 2.75% “over 2023”, up from 2.5% the RBA predicted after its December board meeting. In the December quarter, that inflation tally was 2.6% – the highest since mid-2014 – and the RBA said today it expects the pace to accelerate to “around 3.25%” in coming quarters.
The RBA also cut its jobless rate projection to below 4% in 2022 and “around 3.75%” by the end of 2023. That compared with predictions of 4.25-4.5% in 2022 and 4% next year, as per the banks’ statement on monetary policy released last November.
Lowe cautioned that some uncertainties remain, including the persistence of disruptions to supply chains and distribution networks from Omicron and their ongoing effects on prices.
Another uncertainty is wage growth, which so far “remains modest and it is likely to be some time yet before aggregate wages growth is at a rate consistent with inflation”, he said.
The lowest jobless rate in 13 years during the December quarter may also nudge wages higher. The RBA’s most recent rate rise was in November 2010.
Still, “the Board is prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve”, Lowe concluded.
Even without a firm date from the RBA, investors are tipping the first move by May or June, assuming the rise is to 0.25%. Private economists are predicting a bit later, perhaps August.
Back at the last RBA meeting in December, the bank said it would continue to buy government securities at the rate of $4bn a week “until at least mid-February 2022”, and today it put a firm date to its cessation.
The bond-buying, which also has the effect of driving down yields and making it cheaper to borrow, has seen the RBA acquire about a third of government debt totalling close to $350bn, compared with about $16bn when the program began.
“Since the start of the pandemic, the RBA’s balance sheet has more than tripled to around $640bn, with this expansion providing continuing support to the economy,” Lowe said, adding the board will consider “the issue of the reinvestment of the proceeds of future bond maturities” or how it will unwind its positions at its meeting in May.
Westpac said the RBA’s comments offered few surprises, and the Australian dollar dropped against the US dollar as a result. It eased to 70.35 US cents from 70.7 US cents just prior to the statement.
Warwick McKibbin, a former RBA board member, welcomed the decision by Lowe to avoid setting a rate rise date.
“Basically, they’ve gone back to their target being the inflation outcome, and ending the bond purchases is the right thing to do,” said McKibbin, a professor of economics at the Australian National University, adding “to specify the new target in terms of sustainable inflation around the band [of 2-3% inflation] is the right way to pronounce policy.”
McKibbin predicts the RBA will “certainly” lift interest rates before the end of the year. The challenge for the bank is to determine how much any rise in prices is caused by supply chain troubles rather than increased demand.
“To the extent that is supply driven, you don’t want to raise rates in the face of that because you just make the output losses worse,” McKibbin said. “In America, it’s clearly demand-driven more so than supply-driven, but in Australia’s not quite so clear.”
The US Federal Reserve, the country’s central bank, last week said it would start raising interest rates next month, joining the UK and New Zealand among those to have moved.
Major banks are predicting a rate rise by the second half of this year, with Westpac and the CBA tipping August and the ANZ September.
