ANZ: Two rate hikes are coming in early 2018

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ANZ’s new forecasting tool is currently predicting that the Reserve Bank will get hawkish sooner rather than later.

How hawkish? The bank’s Bias Index — introduced last month — is currently forecasting two rate increases in the first half of 2018.

The Bias Index formulates a predictive model for the future direction of Australian interest rates, based on computational analysis of the wording in the Reserve Bank’s monthly statement.

Based on the wording used in the RBA’s September statement, the prospect of an earlier rate hike appears to have increased:

ANZ considered the results of the Bias Index with another measure for the direction of interest rates they call the RBA Reaction Function.

“This model uses the RBA’s forecasts for inflation and unemployment to determine a point estimate for the cash rate, based off the Bank’s past responses to these two variables,” the bank said.

The results of the Reaction Function also lean towards a slight tightening bias in the RBA’s future interest rate settings, although not as aggressively as the Bias Index:

In considering the difference between the two, ANZ analysts identified the main reason for the Bias Index’s aggressive prediction — it’s picking up more references to financial stability in the wording of the RBA’s monthly statement.

A focus on financial stability would signal an upward bias in interest rates, in order to reign in excessive house price growth.

“Since this has never explicitly driven changes in the cash rate in the past, we are unable to calibrate that into our RBA Reaction Function,” ANZ said.

The bank’s analysts considered whether less weight should be attributed to the bias index in that case, given that the RBA hasn’t acted directly based on financial stability concerns.

In addition, regulators have used macro-prudential measures as another way to control housing risk.

“The only problem with that interpretation is that the RBA has made it clear that the potential boost to household debt has already affected its willingness to cut the cash rate further,” the bank said.

Logically then, the RBA might also raise rates to achieve the same goal.

Add it all up, and ANZ said that the aggressive result from the latest edition of the Bias Index shouldn’t be discarded.

Given that the bank’s Reaction Function is also leaning towards tighter monetary policy, we should at least be “paying attention” to the Bias Index.

“As we have noted in previous research, the risk of RBA rate hikes in 2018 appears to be rising,” the bank concluded.

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