Why Australia may be the canary in the coal mine on interest rates

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A tinkle of warning bells is ringing Down Under for investors still waiting for recessions to bite or eagerly anticipating a swift global pivot to interest rate cuts.

Earlier this month, Australia’s central bank — the Reserve Bank of Australia — decided to keep its main interest rate on hold at 4.35 per cent. Nothing alarming there. But in a statement, rate setters indicated that the next move could conceivably be up, not down.

“A further increase in interest rates cannot be ruled out. While recent data indicate that inflation is easing, it remains high,” the RBA said. “The Board expects that it will be some time yet before inflation is sustainably in the target range.”

This, of course, is central bank speak, and not a promise of any course of action. As RBA governor Michele Bullock said shortly afterwards in parliament, a range of options is still available. “What I said at the press conference was, ‘We’re not ruling out rising interest rates’. We are actually not ruling one in either,” she said, adding that “we don’t have a crystal ball”. She is acutely aware of the risk that the RBA ramps up rates too high for the economy to bear.

To some extent, such comments represent the type of even-handed data dependency that we are familiar with from all the developed-market rates authorities. But it was still somewhat jarring, and a more hawkish tone than most market participants had been anticipating. Some investors believe Australia offers a cautionary tale.

For Christopher Mahon, head of multi-asset at Columbia Threadneedle in London, the country’s example goes some way to illustrating that this time really is different. He has been referring to Australia as the “canary in the coal mine” for some time because it suggests, heretical as it may sound, that the sharp ascent in rates has a much less meaningful impact on the real economy than we are conditioned to expect.

As he outlined in a note last month, Australia was widely viewed in 2022 as one of the developed economies closest to the firing line in the period of intense interest rate rises, particularly because mortgages tend to be set at floating rates, or on one- to three-year fixes, far from the US norm for 30-year home loan deals. In theory, that means Australian households should feel the burn quickly.

But even after more than 4 percentage points of rate rises in less than two years, the Australian consumer is down but not out. “A reader would have to use a magnifying glass to see substantive impact on indicators such as employment, output or real estate,” he wrote. So the RBA simply has to leave the door open to more rate rises.

Assumptions for swift rate cuts are also on shaky ground in New Zealand. Last week, regional bank ANZ flipped its view on what the Reserve Bank of New Zealand will do next. As recently as January, it thought the central bank would start pruning rates back in August. Now it is forecasting two more rate rises by April, taking the benchmark rate to 6 per cent.

The RBNZ did say towards the end of last year that it stood ready to raise rates again after a pause if it thought its battle with inflation was stumbling. “We don’t think the Reserve Bank was bluffing, we think they were calling it like they see it,” ANZ’s chief economist for New Zealand, Sharon Zollner said in a podcast. “If the Reserve Bank does follow through and hike in February, despite the fact that the economy is obviously weak . . . I think that would certainly get some international attention.” It certainly would.

Mahon suggests the absence of a deep recession in Australia shows that the private sector was strikingly disciplined through the Covid-era rate cuts. Households and businesses did not feast on cheap money, opting to build up savings and refinance at lower rates for the longer term. “It’s the government sector that has been the least disciplined,” he says. The view that the aggressive increases of the past couple of years will lead to a recession is flat-out wrong, he adds.

Plenty of fund managers out there disagree with this analysis, and the pattern in Australia does not necessarily translate to the US, which has the most global market impact. Investors point to elevated levels of US credit card and auto loan delinquency as evidence that the elusive US recession could be coming in to view. (Yes, we have heard this before and yes it was wrong.)

But futures markets have already swung from anticipating six rate cuts from the US this year to three or four. If New Zealand does jump the other way this month, it is easy to imagine US stocks and government bonds recoiling in shock. Its central bank meets on February 28, just in case you’re wondering.

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