Macroscope | Interest rates could stay higher for longer. Australia, New Zealand show why

Just months after investors were convinced interest rates would come down sharply this year, expectations have been significantly reduced

The experience of Australia and New Zealand shows that when inflation remains sticky and employment holds up, there is little room for central bankers to consider rate cuts

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Pedestrians pass a Seafolly store in the central business district in Sydney on February 6. Australia’s central bank kept interest rates unchanged at its first meeting of a revamped policy schedule and signalled further tightening remains possible, sending the currency and bond yields higher. Photo: Bloomberg

Published: 5:30am, 1 Mar 2024Updated: 5:59am, 1 Mar 2024

At the end of last year, investors were convinced that interest rates in the world’s leading economies would come down sharply this year. Following the US Federal Reserve’s unexpected signal last December that its monetary tightening campaign was over and that it expected borrowing costs to fall by three-quarters of a percentage point in 2024, bond markets began pricing in much sharper cuts.

What a difference a few months make. At the start of this year, investors were betting the Fed would reduce rates by as much as 1.5 percentage points this year. By the beginning of this week, markets were pricing in roughly half the amount of monetary easing.

As Deutsche Bank pointed out in a report published on Monday, “this continues a theme over the last couple of years, whereby investors have repeatedly been too quick to price in a dovish pivot”. It also raises deeper questions about whether the most aggressive tightening campaign in decades is well and truly over.

The experience of the Antipodes suggests the case for rate cuts is by no means straightforward. At its last policy meeting on February 6, the Reserve Bank of Australia (RBA) not only debated whether to keep increasing rates, it refused to rule out further tightening in the coming months because of persistently elevated inflation which stood at 4.1 per cent in the final quarter of last year. That is significantly above the RBA’s 2-3 per cent target range.

Wage growth in Australia accelerated last quarter, rising 4.2 per cent on an annualised basis, the fastest pace since 2009. The RBA expects core, or underlying, inflation to return to the midpoint of its target band only in 2026, underscoring the stickiness of prices and the need for policy to remain restrictive for a while longer.

The resilience of Australia’s economy to the sharp rise in borrowing costs is most apparent in the housing market, where prices recovered sharply last year following a brief downturn and have risen for 12 straight months. Home values in Sydney, the most expensive market, in January were only 2.4 per cent below their all-time high in January 2022, according to CoreLogic.

.css-1m2rp1p{color:#34b8b5;}Macroscope | Interest rates could stay higher for longer. Australia, New Zealand show why

Macroscope | Interest rates could stay higher for longer. Australia, New Zealand show why