On what was a quiet day for Australian markets, the main talking point for many analysts, traders and investors on Wednesday was an article penned by John Edwards, a former member of the Reserve Bank of Australia (RBA) board.
Posted on the Lowy Institute’s website, Edwards suggested that it was time for the RBA to get interest rates “back to normal”, claiming eight interest rate increases over the next couple of years was “distinctly possible if the RBA’s economic forecasts prove correct.”
Eight increases over 2018 and 2019, taking the cash rate from 1.5% to 3.5%. Mortgage, business and personal borrowing rates would be substantially higher as a consequence.
It’s a punchy call, an incredibly aggressive tightening cycle that few currently foresee, let alone believe is rational.
Safe to say, the Commonwealth Bank’s fixed income research team don’t agree, suggesting that it will be a “long time” until rates will need to be at 3.5% or higher.
Before we hear its assessment, this chart shows current market expectations and the CBA fixed income team’s view on the outlook for the cash rate, comparing it to the forecast floated by Edwards.
Clearly a wide gap between what the CBA and markets are currently thinking and the outlook offered by Edwards. The CBA team reckon there’s a good reason for that.
“The Edwardian chart of hikes presented looks like a stairway to heaven. But it would be more of a stairway to crucification for households, and well above what most economists deem to be the new neutral,” the bank says.
“We estimate the new neutral is optimisitically 2.75-3%, not 3.5%. And that it is a long time before neutral will be appropriate.”
A solid rebuttal of Edwards’ view if there ever was one, and one that mirrored the vast majority of views heard yesterday.
In the CBA’s opinion, instead of beginning a tightening schedule early next year as Edwards suggests, it says the risk over the next 12 months is that the RBA will cut official interest rates again.
“Our view is the RBA cash rate is much more likely to fall than rise over the next year. If anything, we think they’ll cut,” it says.
“And if we find ourselves in a world where the RBA moves to a tightening bias, it’s 2019 and beyond that will move most.”
While it strongly disagrees with the view presented by Edwards, it admits it could be wrong and he might be right, but even if that happens it will still be good news for Australia.
“Let’s face it, if Edwards is right, we’re in a much better world than most think possible today,” it says.