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Reserve Bank of Australia won’t raise rates for now

Despite a hot labor market, soaring inflation, hikes by other central banks and rising bond yields, the Reserve Bank of Australia can still cite subdued wage growth as a reason to maintain its accommodative policy, therefore providing no assistance to Australia. dollar. We do not expect wage growth to remain weak this year.

Reasons to be dovish – There are not many

Over the past few months, the Reserve Bank of Australia (RBA) has defined the conditions it must meet in order to be able to raise its key rates. These are:

  1. Real inflation is sustainably within the target range of 2-3%.

  2. Wage growth will have to be at least 3% (benchmark wage price index).

  3. Actions of other central banks.

  4. How the Australian bond market works.

A quick look at these conditions shows that most of them are met.

Inflation: high and likely to stay above target

Headline inflation in 4Q21 was 3.5%, and there is additional upward pressure on short-term inflation as the reopening of the economy generates a positive demand shock to the economy, and high commodity prices affect consumer prices. The trimmed mean and weighted median measures of inflation are also above the midpoint of the RBA’s 2-3% target range. The key, however, is the RBA’s use of the word ‘sustainably’. This could be interpreted a number of ways, but persistent inflation above the target range for more than a quarter would likely go a long way in ticking this box.

What might be more compelling for the RBA, however, would be signs that wage growth was high enough to keep inflation buoyant. And for that to happen, he said wage growth will need to reach 3% or more.

The 4Q21 Wage Price Index was released recently and rose, but only to 2.3% from 2.2%. We won’t get any more data on this for another quarter. We believe there is a strong chance that wage growth will pick up faster this year, although wage inflation may still be just below the 3% rate for 1Q22, and we may have to wait publication of 2Q figures for this condition to be met.

Headline Inflation and Core Measures in Australia

Source: CEIC, ING

The actions of other central banks

When the RBA talks about heeding the actions of other central banks, it really means the US Federal Reserve. The Fed hasn’t started the hike yet, but there’s no denying it will start in March, and maybe even with a 50 basis point hike. Expected increases over the rest of the year seem very likely to follow.

The RBA has long been careful to position itself on the dovish side of the Fed to prevent the Australian dollar (AUD) from appreciating too much. But given the likely actions of the Fed, and indeed the Bank of England, the Reserve Bank of New Zealand and the Bank of Korea, the rift between the RBA and other central banks will widen. considerably in the near future, allowing it to recover without any problems. undue reading to the currency.

The last factor mentioned by the RBA is the state of the bond market. It’s a bit ambiguous, but you can imagine what the RBA wouldn’t want to see is spreads on Australian government bonds widening relative to US Treasuries – for example, because the market believed they were behind the curve. Right now the spreads are widening, but not that much. It is worth watching, however, as financial conditions are the sum of short and long rates and the competitiveness of the currency. Therefore, keeping policy rates low for longer than the market deems appropriate may not provide the desired accommodative financial conditions.

Putting it all together, the Reserve Bank of Australia will likely continue its gradual return to the moon from previous commitments to keep rates unchanged for the next few years, but it can hold on to subdued wage numbers for now. to justify his position. Even if the wage figures do not exceed 3% before the publication of 2Q22 (most likely in August 2022), they could come closer during the second quarter. With the addition of widening spreads, this could encourage a repricing by the RBA as early as 2Q22, as we believe the cash rate target could be pushed to 0.25% from 0.10% currently.

Australian and US 10-year bond yields

Graphic

Source: CEIC

AUD: external factors stay in driver’s seat

Despite no indications from the RBA that a policy shift to tightening was imminent, markets continued to price in 150 basis point rate hikes in Australia over the next 12 months. This is partly due to the market pricing in Fed rate expectations, but it also highlights some downside risks for the AUD if the RBA maintains a very cautious and gradual approach to monetary tightening this week.

That said, RBA policy expectations have had a fairly limited impact on AUD/USD over the past few months, with external drivers and swings in the USD being the main drivers for the pair. This should remain the case in the current market environment, where the Russian-Ukrainian crisis means that any currency impact from domestic events will quickly be overshadowed.

Graphic

Source: Refinitiv, ING

As the chart above shows, the AUD is less exposed than European currencies to fluctuations in the Russian ruble (RUB) – which is seen as a benchmark for Russian-Ukrainian tensions – but given its high beta against risk sentiment, the AUD still faces considerable downside risks. Incidentally, the sale of iron ore as China aims to curb price speculation may also be a drag for the AUD. Without the help of the RBA, AUD/USD could break back below 0.7100 in the near term as the external environment deteriorates.

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