Many notable differences in monetary policy preferences

Australia pauses rate hikes to assess tightening impact

>> Central banks’ monetary policy faces challenges

It seems fair to say that advanced-country central banks, bar the Bank of Japan, are either at, or close to, the end of their rate-tightening cycles. The cycle has clearly been very aggressive but so too, of course, has been the rise in inflation that prompted the policy tightening. For some time, it seemed that central banks were moving as one. Some central banks might have started rate hikes slightly earlier compared to others and there was obvious discrepancies in the size of rate hikes delivered meeting by meeting.

Nonetheless, through much of last year just about all advanced-country central banks were hiking rates at every meeting and this has continued into early 2023 – for most. We say for most because a couple of central banks have signalled a pause. The Bank of Canada was the first and the Reserve Bank of Australia has followed suit. However, what we notice is that the economic conditions and degree of monetary tightening to date between the ‘increasers’ and the ‘pausers’ is actually very similar.

In other words, those that have paused don’t seem to have done so because their inflation is falling especially quickly, or because their economies are crumbling, or because they have tightened much more. This suggests that the different preferences of policymakers are coming into play here when it comes to the trade off between inflation reduction on one side and economic weakness on the other.

Take Australia and New Zealand. Here we have seen the Reserve Bank of New Zealand push on with rate hikes while the Reserve Bank of Australia has paused. However, on a very simple level, the RBNZ has already lifted rates by more than the RBA in this cycle (500 bps against 350 bps) and headline inflation at least seems to have stabilised in New Zealand, while it is still rising in Australia.

Moreover, if financial stability is thought to be part of the discrepancy it is probably worth noting that NZ seems to face a greater risk of slumping property prices – and hence wealth – than Australia. And it is not just in these two countries where glaring discrepancies seem to exist.

>> Pressure of high interest rate eased

If we look at the US and Canada, both are now seeing decent falls in headline inflation while more general economic conditions seem pretty similar and yet the BoC has paused while the Fed is expected to hike again. Here too the Fed has already hiked by more than the BoC (by 50-bps) and hence we might be forgiven for thinking that the pause, as it were, should be on the other foot.

So why is there this difference and does it matter when it comes to relative asset prices such as currencies? The difference may partly come from the different preferences of policymakers. RBA Governor Lowe spoke about this last week. He argued that the Bank is more content than some other central banks to see inflation fall at a relatively slower pace, if it means less damage to the economy, particularly the labour market.

In the RBA’s case, inflation is expected to be back to the top of the 2-3% target range by the middle of 2025. Lowe argued that the Bank could set policy to try to achieve this a year earlier, but the cost would likely be more economic weakness and higher unemployment than the Bank wants to accept. Should we take from this that those pushing on with rate hikes, like the Fed and the RBNZ are being too hawkish and risk significant recessions and significant increases in unemployment?

“This is hard to say, for while there is a commonality in the global growth, inflation and policy situation, there are clearly notable individual differences as well. Nonetheless, for now we might see those who pause first experience the most currency weakness. However, in the end, if their policy preferences prove to be the more appropriate ones their currencies should come roaring back – and that’s what we expect to happen”, said Mr. Steve Barrow, Head of Standard Bank G10 Strategy.