August 29, 2018 by Dymphna

Rate Hikes: Did I get it wrong?

Markets still think rate hikes are coming. Turn it up.

Ok, let me give you a little update. Back in May I noted that the markets and most people were expecting the next move in interest rates to be up.

I said they were crazy:

I’m way out on my own here, but hear me out and tell me what you think

Over on, you can bet whether the next interest rate move will be up or down. (It’s hidden away in the ‘novelties’ section).

Right now, the result that the next move is up is paying 1.2, while the odds that rates go down is paying 3.7.

That’s quite a spread, and it aligns with economist sentiment in the market. There seems to be a lot of confidence that the next rate move will be up.

I have no idea where they are getting this from.

Those odds have since moved significantly towards my position. It’s now 1.5 and 2.4. But I still think this is way off.

Particularly with the news last week that the RBA is updating their inflation forecasts.

Bill Evans from Westpac has the details:

The Reserve Bank’s August Statement on Monetary Policy provides few surprises.

Of most interest in the Statement is the update in the Bank’s forecasts. In particular, this update includes another six months of forecasts to cover the whole of 2020.

The significant change from May comes with the inflation forecasts. Headline inflation to December 2018 has been revised down from 2 ¼ per cent to 1 ¾ per cent. Underlying inflation to December 2018 has been revised down from 2 per cent to 1 ¾ per cent.

If those forecasts prove correct, then 2018 will be the fifth consecutive calendar year in which headline inflation has printed below the bottom of the 2-3% target band and the third consecutive year when underlying inflation has been the below the bottom of the band.

So the RBA is slashing its inflation forecasts (I also thought they’d do that too).

This is significant. Remember that the RBA is an “inflation targeting central bank”. That is, they use interest rates pretty much exclusively to target inflation.

Their target for inflation is for it to land between 2 and 3%, over the course of the cycle. So there’s a bit of wiggle room, but between 2 and 3%.

The RBA are now saying though that we’re not going to hit that target, not until 2020, and then only just (the purple bars here are the ones that matter).

So look at that. The grey dotted line is the bottom of the target band, and what you’re seeing there is a continual string of misses.

So tell me how you justify raising rates when even as far out as 2020, you’re only just squeaking into your target band.

It’d be a very brave RBA that raised rates on the back of that outlook.

Because, realistically, you’re not going to be raising rates unless you thought that you were going to overshoot your target. But no one at the RBA seems to think that’s likely any time soon.

So why raise rates?

I just don’t see it happening.

I know the RBA and Governor Phil Lowe are out there saying that the next move is up, but I just don’t believe them. I’m surprised so many people in the market do.

And so if I was a betting woman (I’m not. I take risks, not gambles), my money would still be on the next move being down.

The markets and everyone still seem to be way off the beam here.