It looks like markets misinterpreted the RBA’s chat about neutral interest rate settings

Photo: Ezra Shaw/Getty

Financial markets may have jumped the gun in pricing in an increased likelihood that the Reserve Bank of Australia (RBA) will start to hike interest rates, potentially as soon as the end of this year.

According to the Australian Financial Review, citing unnamed sources, the discussion at the RBA’s July monetary policy board meeting about Australia’s new normal cash rate level was part of a regular monthly “deep dive” into key policy topics that was planned six months ago.

“Many in markets appear to have over-interpreted the central bank’s decision to discuss at this month’s board meeting its research into the neutral nominal cash rate,” the AFR said.

“Its inclusion was not intended as a hard signal over the current or near-term stance of monetary policy, but was aimed at informing board members about more longer-term issues.”

The comments make it look like the RBA got on the blower in order to quell growing speculation that it may begin to tighten policy far sooner than what many had previously thought.

The discussion on the Australia’s new neutral policy level, fortuitously located under the the headline of “Considerations for Monetary Policy” in the minutes, was interpreted by some as a sign the RBA was signalling the start of policy tightening, especially with the bank noting that “monetary policy had been clearly expansionary for the preceding five years or so”.

That admission, along with a more optimistic tone towards the outlook for the economy and labour market conditions than that seen in the July monetary policy statement, saw the Aussie dollar rocket to a more than 2-year high above 79 US cents as traders moved to price a rate hike by the middle of next year.

Sally Auld, chief economist and head of Australia and New Zealand fixed income and FX strategy at JP Morgan, says that markets overreacted to the discussion on Australia’s neutral policy level.

“The agenda for RBA board meetings often includes items for discussion that are not directly related to the assessment of economic conditions in the past month. This is particularly the case for the RBA board, which unlike other central banks, is not comprised of professional economists,” she said in a note following the release of the minutes.

As such, Auld says that there is sometimes a need to “educate” board members on theoretical topics that are related to economics and monetary policy.

“In this context, the discussion around the neutral rate doesn’t look so unusual,” she said.

Many other prominent economists offered a similar view to Auld’s following the release of the minutes, although, to date, that doesn’t seem to have resonated much across financial markets.

We may get some clarity as to who’s right and who’s wrong on that front in the days ahead with several leading RBA officials due to deliver speeches.

Guy Debelle, deputy governor, will speak in Adelaide today at 12.40pm AEST. That will be followed up by a speech from governor Philip Lowe on Wednesday next week.

Martina Song, currency strategist at Westpac, says that these speeches could be “opportunities for officials to talk the AUD lower or dampen rate hike expectations”.

You can read more at the AFR here.

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