The Governor’s bubble

Image: Pixabay

TL;DR

For the year to December 2022, Australian CPI printed 7.8%. But the month-on-month rate of change in the rate was a whopping 15%.

The Reserve Bank of Australia (RBA) has been trying to tame inflation by increasing interest rates. It’s not there yet and so far, it’s incurred a $37 billion loss on balance sheet from purchasing bonds that are worth less than they once were (due to interest rate increases) and now the RBA is subject to an independent review.

At the same time, household after tax disposable income and savings are cratering. Interest rate rises and high consumption are creating a cost-of-living crisis for large swathes of Aussies, with less readies to spend.

Which way will Governor Lowe move at the monetary policy meeting next week? Will he finally get serious about tackling inflation (and normalising monetary policy) with meaningful interest rate increases, potentially risking more balance sheet losses? Or will he be tempted to hand out some relief to exposed households by going smaller, or pausing?

While it’s not possible to be half pregnant, let’s look at both sides of the argument.

What happened with inflation in December?

Australian inflation measured by CPI printed 7.8% for the year that was.

But there was a spurt in December with a print of 8.4%, making a month-on-month change in the rate of inflation of 15% - that’s a pretty meaningful increase.

And the annual rate of change in CPI, from December 2021 to December 2022 was a hefty 115%.

Prices doubled in a year, and then some.

As we all know, like many other centrals the RBA has been raising interest rates in an attempt to kill off inflation.

But here in Oz, the cash rate target is still a mere 3.10% and the last couple of rate rises were 25 basis point sleepy horse tail flicks..........so the question is whether the RBA bank board is really serious about tackling inflation or whether it’s a political response.

That’s rhetorical, but what we do know is that Governor Lowe is minding a $37 billion negative equity/balance sheet gap/loss from COVID response yield curve control (YCC) and that the RBA is under independent review.

Will the next monetary policy decision on 7 February be a little influenced by this?

And while that’s yet to emerge, disposable income and savings continue to crater for Australian households, and real wages are negative. On the other hand, consumer spending and employment are both strong. Hmmm……

So what?

Well, all of the above still means that more scarce dollars are being spent by Aussies on goods and services at inflated prices, as well as being hoovered up by banks in the form of higher personal loan and mortgage servicing costs. Banks are winning.

But does Governor Lowe think he’s done enough? Does he feel he needs to mete out more pain with further interest rate rises? And what does his board think?

After all, debt is deflationary and so too is technology and our fast-ageing demographic, and sooner or later supply chains will heal and inflation will have been transitory, right?

In flimsy support of the above, here’s the Australian Producer Price Index (PPI) detail for December, sourced from the RBA itself.

Source: RBA

If the Governor is looking for an excuse to pause and re-blow his liquidity bubble, the declines shaded in yellow above might just give him that excuse.

On the other hand, inflation is burning a fire under a labour government.

Now what?

Well, it depends.

Can Governor Lowe argue that deflationary forces will happen fast enough to take 7.8% CPI down to 3% or 4% or a level that will create positive real wages, soon?

If he can, then that position would be consistent with a small rate rise or a pause.

Alternatively, and in light of the 15% acceleration in CPI in December and apparent employment resilience in the reported numbers, it might be time to get serious about meaningful interest rate rises - even if it is in the midst of a cost-of-living war that his RBA helped to create.

That position would be more consistent with tighter policy for longer and higher interest rates - and still very low unemployment and high consumption rates provide ammunition to continue tightening.

But this does carry a credibility downside for Governor Lowe and his board because existing fixed bond yields look relatively unattractive when interest rates go up and prices move lower. Depending on what part of the yield curve is affected, the RBA could be looking at more mark-to-market losses on some of last year’s YCC purchases.

So, what do you think?

(a) Popularity liquidity bubble pump up (<25 basis point hike or pause) on flimsy ground.

(b) Householder root canal treatment (minimum 25 basis points and preferably higher) to stamp on prices but risk more losses on RBA balance sheet.

(c) Pretend it’s possible to be half pregnant.

But can you really be half pregnant? I don’t think so, but we will find out on February 7.

You can read more about this and related topics in the latest edition of NextPerspective, which I’ll be releasing tomorrow.

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See you in the market.

Mike

Image: Tabitha Mort

Next Level Corporate Advisory is a leading M&A, capital and corporate development advisor with a multi-decade track record in transforming businesses and helping owners with customised financings, mergers, acquisitions and divestments, in and out of Australia.

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