One simple chart explains why the RBA isn't hiking interest rates like other central banks

  • US unemployment is at a level that leads to faster inflation. Australia’s jobs market is some way off reaching that threshold.
  • A timeline for RBA interest rate hikes will be closely tied to unemployment falling toward the bank’s full employment rate of 5%.
  • It offers a playbook for what the RBA may do next.

No here’s an interesting chart from the National Australia Bank (NAB) that explains why the US Federal Reserve (Fed) is hiking interest rates while the Reserve Bank of Australia (RBA) sit on its hands.

Source: NAB

It shows the US and Australian unemployment rates overlaid against respective estimates for the non-accelerating inflation rate of unemployment, or NAIRU, for both countries.

As its name suggests, NAIRU is a level where unemployment generally leads to stable inflationary pressures. An unemployment rate below NAIRU typically leads to an acceleration in inflationary pressures, and vice versa.

On one hand, unemployment in the US currently sits at 4.1%, well below the 4.9% NAIRU estimate offered by the OECD. On the other, Australia’s unemployment rate, at 5.5%, is currently above the RBA’s own NAIRU estimate of around 5%.

So unemployment in the US sits at a level that typically leads to faster inflation, the exact opposite scenario to Australia.

It’s little wonder why the Fed has been lifting rates for well over two years, while the RBA has kept rates steady at a record-low level of 1.5% since August 2016.

Along with explaining the recent divergence in policy between the Fed and RBA, Peter Jolly, Global Head of Research at the NAB, thinks the chart also provides something of playbook on what the RBA may do in the period ahead.

“If the RBA is to follow the Fed road map, the timing for ‘lift-off’ will be determined by how quickly the current 5.5% unemployment rate falls towards its full employment rate [of 5%] and wages turn up,” he says.

“Importantly, the RBA expects ‘progress is likely to be only gradual’ in reducing unemployment and returning inflation to the midpoint of the [bank’s 2-3%] inflation target.”

So when unemployment in Australia falls towards 5%, it could be around the time the RBA begins to lift interest rates, at least based off what we’ve seen from the Fed.

While the RBA has stressed on countless occasions that “progress is likely to be only gradual”, Jolly says it could arrive as soon as the second half of this year should lead indicators on unemployment and wage growth be on the money.

“NAB currently forecasts RBA ‘lift-off’ in the second half of 2018, with rate hikes pencilled in for August and November,” he says.

“We acknowledge that unemployment and wage data will need to improve materially between now and August for them to hike by then… [but] the good news is that the forward indicators do point to continued strong employment growth as well as some lift in wages growth in the next few quarters.”

With leading labour market indicators all heading in the right direction, Jolly says that markets are being far too cautious in not fully pricing a 25 basis point rate increase until early next year.

“While there is a risk our forecast for RBA hikes from August may be delayed, the RBA is now considering when is the correct time to begin to reduce accommodation,” he says.

“Market pricing now looks too benign with a full RBA hike not priced until March 2019.”

Australia’s January jobs report will be released on Thursday, February 15.

That will be followed six days later by Australia’s Q4 wage price index, a report that has taken on significant importance given the RBA has now tied to performance of wage growth in helping to meet its inflation goals.

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