Australia not the canary in the coal mine on global rates

Plus, revisiting section 11 of the RBA Act

Katie Martin had a piece in the FT based on a Columbia Threadneedle note arguing that Australia is the canary in the coal mine of the global interest rate cycle. The RBA’s maintained tightening bias is said to portend an unfinished global tightening cycle.

This is a misreading on a number of counts. The RBA has lagged the global tightening cycle. It was slow to start tightening relative to some of its peers and dragged the chain on tightening in the second half of 2023 before putting in a catch-up rate increase in November. Note the issue here is more the timing rather than the magnitude of the tightening cycle. Australia enjoyed a smaller run-up in its inflation rate than its peers. The RBA consequently did not need to tighten as aggressively, but timeliness was still an issue. Eyeballing the chart of central bank policy rates and expectations below does not suggesting a leading relationship, either retrospectively or prospectively.

Source: Macrobond.

Based on the market-implied expectations shown above, the RBA is expected to preside over a relatively modest easing cycle relative to its peers. As we have noted previously, the RBA’s inaction bias means that it often smooths its way through the business cycle, letting the cycle come to it rather than bringing policy to bear on the cycle. While I have no problem with the notion that Australia (and New Zealand) are in many respects on the front line of the global business cycle, the RBA’s official cash rate has not been the most timely indicator of the global rate cycle.

The Columbia Threadneedle note makes much of the resilience of the Australian economy to the RBA’s tightening cycle to argue that the global economy is similarly resilient, suggesting higher for longer official interest rates. But a more plausible interpretation is not that the Australian and global economies are much more resilient than in the past, but that the effective stance of monetary policy has not been as tight as many assume. As market monetarists have often noted, the run-up in bond yields is more consistent with market expectations for strong nominal GDP growth than an indication that monetary conditions have been significantly tightened. The RBA does not expect inflation back in the target range before the second half of 2025. That is hardly indicative of restrictive monetary policy.

The Bank of Canada and the RBNZ did lead the global rate cycle coming out of the pandemic, but that was in large part because they had eased more aggressively going into it. The central banks of the dollar bloc periphery are sometimes a good leading indicators of the global rate cycle, but that has been less true of the RBA in the current cycle.