why markets are over-egging future rises

why markets are over-egging future rises

To get to the 4 per cent level, he noted, the RBA board “would have to increase interest rates by 50 basis points at the remaining six meetings of this year, and have a 75 basis point increase in there as well”.

Such a rapid-fire pace of rate rises would hit consumption spending, push home loan payments higher, dent confidence and slow economic activity “quite a lot”.

Interest rate sensitivity

Still, the RBA’s previous forecasting missteps has made Lowe more cautious.

“I don’t think it’s particularly likely, but the market has been a better judge of where interest rates are going than we have over the past few years, so you’ve got to pay attention,” he said.

It is likely that financial markets are overestimating how high the RBA will push interest rates. Australian consumers are extremely sensitive to rising interest rates, given the onerous level of household debt.

Already, the combination of rate increases and a higher cost of living is causing consumer sentiment to sour.

If consumers rein in spending, pressure on prices will abate, and there will be less pressure on the RBA to tighten aggressively.

As Lowe noted, this is precisely the issue that is preoccupying the world’s top central bankers at present. There are, he added, two major schools of thought.

“One is that high inflation is cutting into people’s real incomes. We see this here, but in the United Kingdom, it’s particularly noticeable,” he said.

“Their inflation is going to be above 10 per cent, and incomes maybe rising 4 or 5 per cent. So that’s a cut in real income of 5 or 6 per cent.

“Now that really hurts people. And that’s happening in many advanced economies at the moment.

“So some people are of the view that this cut in real income is going to crimp household spending, economies will slow, perhaps unemployment will rise, and inflation will come down fairly quickly.”

As Lowe observed: “That’s a pretty negative view of the world.”

‘Problems are resolving’

Still, he added, there was a more positive take, which was that the “supply side problems in the global economy can resolve, and are resolving”.

“And that oil prices aren’t going to keep going up at 66 per cent a year – maybe they stabilize, or let’s hope they come down – and that that will change the inflation dynamic.

“And that households, like in Australia, that have built up big buffers will be able to smooth through this period of a hit to their real incomes, and that inflation can come down without the unemployment rate going up too much.

“So they’re the views that people are talking about in the official community.”

The problem, as Lowe noted, was that both of these interpretations were “plausible.”

“I think this is one of the reasons why markets are volatile at the moment. Because we’re all having trouble working out which of those views is more likely to represent reality.”

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