Reserve Bank set to face inflation problem and rate hike dilemma in 2022

One word kept interest rates near zero in the developed world last year, but it is disappearing faster than the value of a stockpile of out-of-favor memes.

This word was “transient”. According to the Macquarie dictionary, it means “during a short time” – a definition which itself requires some definition.

The noun to which the adjective was attached was inflation, the stated objective of most central bank policies.

While each central bank that targets inflation has slightly different targets, the typical target is around 2%.

The Reserve Bank of Australia gives itself a little more flexibility with a target range of 2 to 3%.

Over the past year, inflation in many developed economies has started to rise above target levels, in some cases well beyond them.

Unemployment is back below pre-pandemic levels in the United States, at 3.9%.(Reuters: Jim Young )

The largest economy in the world, the United States, is a prime example.

Its headline consumer price index (CPI) soared above 2% in March, jumped above 4 in April and reached 5 in May.

This is where the term “transient” became popular.

It first appeared in U.S. central bank statements in April and kept popping up after that.

The Federal Reserve operated on the belief that supply chain disruptions and resulting commodity shortages were largely to blame for rising prices, which would abate just as quickly when these bottlenecks took hold. end.

A 37% jump in the price of used cars as new car production stalled due to COVID-related computer chip delays is a case in point.

However, after some stabilization during the Nordic summer, the acceleration in price increases has not stopped.

Chart showing CPI inflation in the United States over the past year.
Inflation in the United States exceeded the Fed’s 2% target in March and has continued to climb sharply since.(Provided: United States Bureau of Labor Statistics)

The annual rise in the headline CPI exceeded 6% in October and reached 7% by the end of the year, its highest level since June 1982.

And the price hike is not just limited to manufactured goods with complex international supply chains.

The cost of housing increased by 4.1%, food prices jumped by 6.3%, clothing rose by 5.8% and energy was the most important, increasing by 29.3 %, fuel having increased by nearly 50%.

Meanwhile, the Fed’s preferred “core” measure, which excludes food and energy, was still up 5.5%, well above its target.

Are interest rates close to zero becoming transitory?

Even before the December numbers were released, Fed Chairman Jerome Powell was moving away from “transitional,” telling Congress late last year that now was “probably a good time to pull that word out.” “.

“The word ‘transient’ has different meanings to different people,” Powell explained.

“We tend to use it to mean it won’t leave a permanent mark in the form of higher inflation.”

True, this is another dictionary definition sometimes given for transient, “not permanent”.

But, in order to ensure that these kinds of price increases aren’t permanent, or at least lasting, most economists believe the Fed will soon have to take action to appease the US economy.

Just before the Omicron wave of COVID-19, the US economy was booming, with unemployment having already fallen to just below 4%, the lowest since the pandemic began.

It’s as close to a certainty as you can get in the markets that the Fed will raise interest rates by March.

However, in recent days, speculation has increased that there could be a surprise rate hike at the start of the Fed’s meeting this week, or that it could make a full-blown rate hike of 0 .5 percentage point in March, down from 0.25.

It wouldn’t be the first major central bank to move.

The Bank of England rose in December and just recorded inflation of 5.4% for that month, justifying this decision.

Closer to home, the Bank of Korea has raised interest rates three times – to 1.25% – and on our doorstep the Reserve Bank of New Zealand has already raised its official interest rate. twice, at 0.75%.

So where does that leave the RBA?

Things are not yet so desperate for the Reserve Bank of Australia, even though its cash rate starts at just 0.1%.

The last local inflation reading for September was 3%.

However, December’s, out of the ABS tomorrow, is expected to be stronger, with Australia’s two biggest property lenders, CBA and Westpac, both falling 3.2%.

That would be above the 2-3% target range, but the RBA’s preferred core measure of consumer prices is expected to rise to a more modest 2.4-2.5%.

Even so, it will be a decisive break after six years of core inflation below the bank’s target.

Gareth Aird
The CBA’s Australian head of economy, Gareth Aird, expects the RBA’s cash rate to rise later this year.(ABC News: John Gunn)

“An underlying inflation outcome in line with our forecast would be a big upside surprise to the RBA’s central scenario for the inflation outlook,” notes CBA’s head of Australian economics Gareth Aird. , in its overview of the CPI.

This is the Quantitative Easing (QE) program which sees the RBA buy $4 billion of Australian federal and state government bonds every week in a bid to keep interest rates lower.

In December, Reserve Bank Governor Philip Lowe said the bank would likely announce in February that bond buying would wind down and end in May.

However, he also said the program could be completely liquidated in February if economic data were better than the RBA’s forecast.

What Aird is saying is that, given tomorrow’s expected inflation figures, combined with the surprise drop in unemployment last week, the RBA’s QE program will end in February.

Why might this interest you?

On the one hand, if you were thinking of taking out an ultra-cheap fixed mortgage, you have now well and truly missed the boat.

The RBA’s QE was one of the factors that kept long-term interest rates lower, and its impending end has already seen banks large and small scramble to raise their fixed rates.

Westpac was the last major bank to move, with another 0.2 percentage point hike last week on its five-year fixed rate following several upward moves last year.

To give an example of the extent to which longer-term fixed rates have risen, Westpac was still offering a 1.89% four-year fixed mortgage in March last year – that same product is now 3.34 %.

Data from RateCity shows that 17 lenders have raised fixed rates so far this year, while none have cut rates over a fixed term of three years or more.

The one area where mortgage interest rate cuts outnumber rate hikes is in variable rate loans.

And the ABC and Westpac warn it will be short-lived.

While the CBA expects the first cash rate hike to come at the end of this year, Westpac has now moved the timing forward in its forecast to August.

Either way, it’s on the prediction that inflation in Australia, like elsewhere in the world, won’t be transient – ​​or at least not transient enough – for the Reserve Bank to ignore.

It also factors in the likelihood that Australia, along with Europe, will end up with some of the lowest interest rates in the developed world as other central banks begin or continue their hikes.

This, in itself, is likely to boost inflation, as the falling Australian dollar makes imports more expensive.

The good news, if you have a mortgage, is that high debt levels in Australia, the US and most developed countries mean this rate hike cycle will likely be limited – Westpac expects that it caps here at 1.75%.

Meanwhile, the bad news? According to RateCity’s calculations, a household with a $500,000 mortgage will need to find more than $100 a week in their budget by March 2024 to meet these additional repayments, and that’s assuming commercial banks don’t increase not rates more than the RBA.

If you’re not the average borrower who’s nearly four years ahead of your repayments, or the typical household who hid nearly 20% of their income during the pandemic, then maybe it’s time to start. to save.

At least soon you should finally be able to get a half decent deposit rate.