There has been a dramatic change as great uncertainty grows over what inflation and interest rates will do to the Australian economy.
Around the world, there is an issue that divides economists, commentators and central bankers alike, an issue that could determine the fate of the global economy and Australia’s economic future.
This single indicator, as defined by the consumer price index, is the key factor in central banks around the world, including Australia’s own RBA interest rate decision process.
In recent years, inflation, as defined by statistical offices, has ceased to be a major problem in it
developed world. In fact, central bankers throughout the developed world have been concerned
that inflation is too low and continues to lower interest rates in the pursuit of higher inflation.
But in one of those ironic little twists and turns that happens in life, they now have a whole lot more than they had anticipated.
Around the world, central bankers have repeatedly insisted that rate hikes were years away, saying they would be telegraphed to the public in good time.
Here in Australia, RBA Governor Philip Lowe continues to insist that interest rate hikes are at least three years away, confirming that it is unlikely that the inflation target of 2-3 per cent will be reached over a longer period.
Rate climbs in all four corners of the world
Despite the popular central bank narrative that interest rates would not rise, they do just that in
nations around the world.
First, it was developing countries that raised rates to protect their currencies and ward off
inflation. Then nations in the former Soviet bloc like Poland and the Czech Republic were forced to raise interest rates.
But lately, inflationary and interest rate pressures have begun to affect how interest rate hikes are priced in the developed world.
And it has happened much faster than many are familiar with.
In August, a survey of economists concluded that the Bank of England would not raise interest rates until at least 2023.
Today, interest rate futures price a Christmas rate hike and a 50-50 chance of a rate hike in both November and December.
It’s a similar story in the United States. Federal Reserve Chairman Jerome Powell continues to insist that inflation is “transient” and that interest rates will not rise for a long time to come.
Despite Powell’s defense of the Fed’s talk of interest rates, interest rate futures are now on the verge of pricing two rate hikes by the end of next year.
Central banks are influential, but they are not gods
While money markets continue to price rate hikes around the world, this brings us to a challenging and often poorly understood point.
Central banks, like the RBA, have enormous power over interest rates, but at the same time they are not all powerful and subject to market forces.
For example, the RBA could in theory resist raising interest rates for quite some time, even if the market had to price an aggressive cycle of rate hikes, and its global peers pulled the trigger on rate hikes.
But in an environment of high inflation, all reluctant central banks will eventually be aligned or faced with the potentially catastrophic consequences of mismanaged monetary policy.
The future of Australian interest rates
Although money markets do not price a near as aggressive rate hike cycle as those in the UK or US, those worlds apart from Governor Lowe’s insist that interest rates will not rise for at least three years.
On October 11, interbank cash interest rate futures priced an interest rate hike for December 2022.
On October 18, an interest rate hike was priced to October 2022.
In the wake of the third-quarter inflation data coming hotter than expected, things have suddenly changed even more dramatically.
As much as 0.25 percent interest rate hikes are now priced in the market for June, August, October and November next year. With a fifth rate hike priced to February 2023.
If the market is correct in February 2023, the RBA cash rate will be at 1.35 percent, an increase of 1.25 percent compared to today’s figure of 0.1 percent.
Whether the market will be correct is a matter of great debate, but it has been wrong many times before.
An unclear future outlook
As we enter an uncertain future, the direction of inflation has become a trillion-dollar issue that could define the outlook for everything from the global economy to Australian interest rates in the years to come.
If inflation remains too hot for comfort, central banks may be forced to raise interest rates, whether they want to or not.
On the other hand, if inflation shows signs of being brought under control, interest rate hikes may end up being much further away than markets currently expect.
Although this week’s stronger-than-expected CPI figures may have given a clue as to where inflation and interest rates will lead in the coming months and years, it may be some time before we know with a high degree of certainty which way it will go. go.
Tarric Brooker is a freelance journalist and social commentator @AvidCommentator