- The US Federal Reserve, Bank of England and Bank of Canada have all increased policy rates recently.
- At the same time, the Reserve Bank of Australia has kept interest rates unchanged for the longest period on record.
- Vastly differing labour market conditions explain the policy divergence over this period.
The US Federal Reserve has hiked interest rates six times since late 2015, including an increase earlier this week. And interest rates in the neighbour to the north, Canada, have also increased three times in the past nine months. The Bank of England has also pushed rates higher, and could so again as early as May. Even the ECB, still purchasing tens of billions of bonds each and every month as part of its asset purchase program, also appears to be moving towards an increase in policy rates at some point next year.
Everywhere you look, major central banks are on the way, or have already started, normalising interest rates.
But not in Australia.
While the Fed, BoC and BoE are all tightening policy, the Reserve Bank of Australia (RBA) appears content to sit on the sidelines, providing no indication in recent communications that it intends to follow in their footsteps, at least in the near-term.
As RBA Governor Philip Lowe pointed out in a speech earlier this year, there’s good reason for the RBA standing pat, noting there’s no rule stating that global interest rates need to move in lock-step with one another.
“We did not lower our interest rates to the extraordinarily low levels seen elsewhere after the financial crisis. Our circumstances were different: we didn’t have a meltdown in the financial system and we experienced a very large cycle in commodity prices and mining investment,” Lowe told the A50 Dinner in Sydney during January.
“Just as we did not move in lock-step on the way down, we don’t need to do so in the other direction.”
Lowe said that, given the current economic circumstances, that it was understandable why some other central banks are raising rates right now.
“They lowered their rates by more than us and, in a number of countries, the unemployment rate is now below conventional estimates of full employment at a time when above-trend growth is expected,” he said.
“Our circumstances are a little different.
“We are still some way from what could be considered full employment and our central scenario for inflation is for it to remain below the midpoint of the medium-term target range for the next couple of years.”
“Full employment”, as Lowe refers to, is the point where lower unemployment will start to push up wage and inflationary pressures. It’s known as the non-accelerating inflation rate of unemployment, or NAIRU for short.
Many think Australia’s NAIRU level is around 5%, although, given the evidence seen in other advanced economies in recent years, some believe it’s now significantly lower.
As seen in the chart below from UBS’ Australian economic team, Australia’s unemployment rate, at 5.6% in February, is still well above this 5% level, in complete contrast to what’s been seen in the US, Eurozone and New Zealand recently.
And, as seen in this next chart, as labour market underutilisation is being rapidly reduced in the US, Canada and Europe, progress in Australia has been considerably slower.
Labour market underutiliation measures the proportion of the labour force who are unemployed or in employment but would like to work more hours.
So, in contrast to Australia, unemployment in other nations is at or below what is regarded as NAIRU, and the number of underutilised workers are continuing to decline as economic conditions improve.
They’re at the point where wage and inflationary pressures are expected to accelerate, a different scenario to that seen in Australia, says George Tharenou, Economist at UBS.
“There is still likely more spare capacity in Australia’s labour market compared with other major economies which are at or below NAIRU, and hence we still don’t see a large lift in wages in the near-term,” he says.
And given the influence wage growth has on domestic inflationary pressures, it’s little wonder why the RBA is, therefore, also choosing to be “different” when it comes to current monetary policy settings.
As Lowe told the A50 Dinner, the key to when the RBA will begin to lift interest rates will be reducing excess capacity in Australia’s labour force.
“We expect… to make further progress in reducing unemployment and having inflation return to the midpoint of the target range,” Lowe said.
“If we do make that progress, at some point it will be appropriate for interest rates in Australia to also start moving up.
“While we do expect steady progress, that progress is likely to be only gradual.
“Given this, the Reserve Bank Board does not see a strong case for a near-term adjustment in monetary policy.”
And given that spare capacity in Australia’s labour market increased in February, even with continued growth in employment, it suggests that it may not just be the near-term that the RBA keeps rates steady, but perhaps the longer-term too.