Interest rates definitely to rise - sometime maybe
The geniuses in the financial markets â€" and they must be geniuses because they’re paid far more than we are â€" think next year will be an absolute ripper. Workers will be getting their first decent pay rise in six years or more. Say, 3 to 4 per cent. Whoopee. Gee, thanks guys.
Find that hard to believe? So do I. It’s the logical implication of the bets they’re making that the Reserve Bank will begin lifting its official interest rate â€" which has been at almost zero for a year â€" by the middle of next year and be up to 1 or 1.25 per cent by the end of next year.
For that to happen, the underlying or core rate of inflation, which has been below the bottom of the Reserve’s 2 to 3 per cent target for years and only just a few weeks ago lifted its head to 2.1 per cent, would need to have shot up close to 3 per cent.
And, because the inflation rate doesn’t rise sustainably unless it’s being driven up by rising wages, an inflation rate approaching 3 per cent couldn’t happen without annual pay rises averaging 3 to 4 per cent.
Reserve Bank governor Dr Philip Lowe has spelt out this relationship between inflation, wages and interest rates almost every time he’s opened his mouth since even before the arrival of the pandemic. He did so again twice last Tuesday and once on Friday.
Reserve Bank governor Philip Lowe is more interested in what is causing inflation rather than the rate.Credit:Dominic Lorrimer
So pay rises of unheard-of size are the logical consequence of the money market’s bets that the Reserve is about to become so desperately worried about soaring wages that it will have raised the official interest rate four or five times in the next 12 months.
Trouble is, I doubt the financial market players are thinking logically. I doubt they’ve thought it through to the extent I just described. The economists who work in the financial markets are well-educated, but this episode makes me wonder whether the guys laying bets in the dealing room even have wages in their mental model of what drives inflation and interest rates.
By the way, I’m not just being disparaging in describing the financial markets as a casino. As Professor John Kay explained in his book Other People’s Money, the buying and selling of currencies, bonds and other real and derivative securities each day in the world’s financial market dwarfs the number of transactions needed by real businesses to conduct their ordinary affairs.
Indeed, Kay told me those genuinely necessary transactions could be put through in about a quarter of an hour a week. So, what are all the remaining transactions? They’re dealers using their bank’s money to trade with dealers from other banks in the hope of making a quick million or two and a fat bonus at the end of the year.
I’m sure these professional gamblers are better at playing poker than you or I would be, but they aren’t trained economists, and they don’t think like economists. Certainly, not like central bank governors.
Lowe, the man with his hand on the lever, says he still doesn’t think a rate rise will be needed until 2024, but last week he admitted things could turn out stronger than he expects
Because Wall Street has the greatest single influence over what happens in the global financial markets, these guys know more about what’s happening â€" and likely to happen â€" in the American economy than their own.
They also have a huge superficial knowledge of what’s been happening in lots of economies in the past few weeks. They know inflation has shot up in the US, Britain and a few other countries, wages have increased somewhat in the US and a few other places, and some minor central banks have started raising their official interest rates.
I think these guys’ mental model of what’s driving interest rates is no more profound than this: prices and wages are rising in the US and other places, rates are already rising around the world, so pretty soon rates will be rising here.
Lowe, the man with his hand on the lever, says he still doesn’t think a rate rise will be needed until 2024, but last week he admitted things could turn out stronger than he expects and make a rise necessary in 2023.
There you are. He’s as good as admitted he’ll have no choice but to start raising rates in a few months’ time. Anyway, that’s what we’re betting on. If we turn out to be wrong, it wouldn’t be the first time, and we won’t lose our jobs. We’ll just lay new bets and keep doing it until we’re right.
Which they will be â€" one day. Since rates can’t go lower it’s a cert that the next move will be up. Right now, when they’ll be going up is known only to God. In the absence of inside intel, I’d rather put my money on Lowe than on those geniuses.
Ross Gittins is the economics editor of the Sydney Morning Herald.
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