Great RBA misread risks Phillip-Lowe style interest rate mess: 'Ignoring the screams'

“And I've seen it before. And I'll see it again."

"Yes, I've seen it before. Just little bits of history repeating.”

These are the lyrics from the iconic Shirley Bassey song, History Repeating.

For those of us with a sense of history, they are pertinent to the current Reserve Bank of Australia (RBA) assessment of economic conditions and investor actions that are pricing in a series of interest rate cuts, starting in the next few months.

Why is it that the RBA is probably making another mess of policy by ignoring, or at least downplaying, what the markets are screaming.

Oh no, it’s Phillip Lowe

In late 2021 the RBA was confident that the then spike in inflation was temporary.

Infamously, RBA Governor Phillip Lowe contemptuously dismissed market pricing for a series of interest rate hikes and said that a 0.1 per cent cash rate was the RBA’s core scenario for monetary policy for the next three years.

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In this episode, markets in Australia were at least six to nine months ahead of the RBA as investors took account of the effects of previous and continuing super-stimulatory policy settings, rising inflation and surging commodity prices to anticipate RBA rate hikes.

Lowe resisted the market signals and we all know how that ended.

It was a painful inflation crisis.

Fast forward to August 2024 and RBA Governor Michele Bullock, similarly but in the other direction to Lowe three years ago, is forecasting inflation will stay high for several more years.

She also chastised markets for getting ahead of themselves for pricing-in interest rate cuts before the end of 2024.

Even after these assertive warnings from Bullock, markets continue to price in a zero possibility of an interest rate hike.

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They continue to put their investment funds into scenarios that take account of interest rate cuts being delivered in the months ahead.

If there were enough believers in the words of the RBA Governor, this is a strategy that would cost these investors huge sums of money.

If, on the other hand, the RBA is wrong, the current policy misstep will cost many tens of thousands of jobs, deliver a rise in business failures and an extended period of economic funk.

It is a high-stakes game the RBA is playing.

RBA vs the money markets

It is fair to ask, what do the narrowly focussed, hugely specialised economists and analysts at the RBA know that agile and insightful global investors pumping hundreds of billions of dollars a day into the financial markets don’t know?

It is an important question.

The week that the RBA missed

The past week has been tumultuous for money markets and readings on the global economy.

Somewhat worryingly, the RBA forecasts that Governor Bullock was defending had been signed off on 31 July, before the market moving US labour market data for July.

The weakness in the US economy was confirmed with news that the unemployment rate rose to 4.3 per cent from a low of 3.4 per cent, with wages growth decelerating on the back of subdued economic conditions.

Such is the concern about the US economic performance and outlook, that markets are currently pricing in more than 100 basis of interest rate cuts in the US before the end of 2024 and close to another 100 basis point through 2025.

The RBA painted a remarkably positive view of the labour market. Its forecast for the unemployment rate to peak at 4.4 per cent is within spitting distance of the current 4.1 per cent.

With Australian GDP growth weak and in annual terms set to slip below 1 per cent in the June quarter, job vacancies in free-fall and already a rise in unemployment from the 3.5 per cent low point in 2023, it would be more than miraculous for the unemployment rate to peak at the rate forecast by the RBA.

This is one issue that investors are giving a lot of weight to.

The RBA’s upbeat assessment of the labour market is an obvious reason why its forecasts do not have inflation falling back to the target range earlier.

If the RBA was a bit more realistic with its forecasts that would see it ratchet down its inflation forecasts.

Acknowledging the unemployment rate is likely to approach 5 per cent, a far more likely result than 4.4 per cent.

Such is the feedback loop in the forecasting process.

Will interest rates go up again? The RBA say they may

The RBA governor outlined the board's thinking at her press conference when she spoke of a possible interest rate hike.

The reasons were:

• domestic demand remains strong.

• Future inflation readings straying well away from a target return.

For most economists, it was a fascinating discussion, and one that saw some of the major banks push back the timing of their forecasts for interest rate cuts.

For investors, the view that interest rates could be hiked was dismissed in its entirety.

As the dust settles, money markets are still fully pricing in a 25 basis point interest rate cut from the RBA during the March quarter 2025, with a further two 25 basis point cuts by the end of that year.

Those investors are, no doubt, taking their cue from global conditions which remain weak and to the downside and the fact that commodity prices are falling which will further enhance the moderation in many goods prices.

It is seven long weeks until the next RBA interest rate announcement on 24 September.

In the time till then there will be two labour force releases, all important data on wages, the June quarter GDP result and one monthly CPI release.

There will be a run of retail sales, building approvals and business surveys which will add some information to how the economy is starting to track into the September quarter.

Developments in the global economy will of course unfold with an identifiable highlight the US Federal Reserve’s interest rate decision on 18 September where the market is torn between a 25 and 50 basis point interest rate cut.

Many other central banks will have likely cut interest rates again by then including possibly Canada, the UK, the Eurozone, and New Zealand, to name a few.