What can the RBA's rate hikes show?

Reserve Bank of Australia Governor Philip Lowe (2nd L) speaks at a parliamentary committee hearing as he sits next to Deputy Governor Guy Debelle (L) in Sydney, Australia February 22, 2019. REUTERS/Tom Westbrook

>> How will the US dollar move if the FED pauses rate hikes?

The RBA decided at its prior meeting in April to pause rate hikes, citing the need to assess more data before deciding whether to continue. It did say at the time that more tightening “may well” be needed to ensure inflation returns to the target. A month later it decided that it had seen enough data and hiked rates again. Is there any lesson here for other central banks, notably the Fed, that might be considering a policy pause as well?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, thinks the answer to this is, yes and no. The ‘yes’ comes about because the RBA’s rate pause came at a time when inflation was still more than twice the target and its unemployment rate was only a tenth above the lowest rate that the country has ever seen.

Many others that might be considering a rate pause right now face a similar economic backdrop. The result of this is that even small disappointments in the quest to bring inflation back to target could lead to a re-think on rates. Indeed, the fact that the RBA rate hike this week was such a big surprise to the market shows that the vast majority thought that even robust data such as the 53k rise in March employment (when the consensus was for 20k) was not sufficient to make the RBA lift rates again.

If we look at the US, payrolls are rising at an average pace of almost 350k over the past year and over the past three months. That’s more than three times the 100k that Fed Chair Powell cited as being the pace of workforce growth. On this basis we could argue that even if payroll growth falls back modestly it will still be inconsistent with meeting the full employment goal for some time.

Inflation, as we know, seems stuck around the 4.5% level for core PCE prices, well above target so, here too, it might not take much disappointment at all (in terms of higher-than-expected inflation) to get the Fed thinking about another hike after a pause.

On the flip-side, why might the RBA’s renewed rate hike say little about what might happen at the Fed and other central banks? For one, the RBA has been more cautious than other central banks during this period of rate hikes. The RBA has hiked by 375-bps against 500-bps for the Fed (if it hikes by 25-bps tonight) and yet its inflation profile is not very different to the Fed and it shares the near-record low unemployment rate. This week’s rate hike might show that the RBA has been too timid and only now it is being forced to catch up to what other central banks have been doing.

>> Central banks’ monetary policy faces challenges

Another factor is that RBA Governor Lowe has argued in the past that the Bank is willing to go easier on rate hikes than some others because it wants to preserve as much of the employment gain as it can. There is also a potential difference because the RBA has not had to confront anything like the banking sector problems that we have seen in the US and this too might have emboldened it to hike rates while the Fed might prove more cautious over time and hence more likely to stick with a view that ‘pause means pause’ when it finally decides to make rate policy data dependent.

So, what is it likely to be? Will the RBA’s volte-face on a rate pause prove a template for what we can expect from the Fed, or not? Mr. Steve Barrow thinks it more likely that it will not. Once the Fed has paused, it will not re-start rate hikes. This being said, it likely that the Fed pauses from a slightly higher rate – of 5.5% - than the 5.25% majority view. “We clearly can’t be sure about this but one thing we are pretty certain about is that data on inflation and employment will have to move notably in the Fed’s direction if the market is to avoid jitters around renewed rate hikes”, said Mr. Steve Barrow.