MNI INTERVIEW: Bonds Saying RBA Underestimating Inflation

The spread between the yield on 10-year Australian commonwealth government bonds and the current level of real interest rates implies higher future inflation and greater risk expectations will de-anchor from the central bank’s forecasts, a former Reserve Bank of Australia economist told MNI.

Mariano Kulish, University of Sydney professor and a former RBA senior manager, said the current yield on 10-year ACGBs of just over 4% inferred 4% inflation over the next decade. Real rates were about zero, which means inflation has to average 4% over the next 10 years, he added.

“My concern around that assumption is that the real rate has been on a downward trend driven by demographics and weak productivity trends,” Kulish told MNI. “That, combined with the long-term rate, tells me that perhaps there are higher inflation expectations in the system that will make stabilising inflation harder.”

CONSISTENTLY STICKY

Since 2021, inflation has consistently proved sticker and harder to tame, Kulish added. “People keep saying inflation is temporary and maybe it is, but maybe not so temporary over the next seven years. I think we risk some de-anchoring of inflation expectations.”

Inflation expectations rose in April, with the expected inflation rate increasing 0.3 percentage points to 4.6%, according to the Melbourne Institute. Meanwhile, the International Monetary Fund has warned of re-accelerating inflation, which could diminish hopes for 2024 rate cuts, according to its World Economic Outlook published earlier in the month.

The 4.6% 10-year yield on U.S. treasuries alongside the U.S. Federal Reserve’s 2% inflation target meant 2.5% inflation had been priced in over the decade, Kulish added. However, American productivity and output growth were stronger, he said, suggesting a higher real rate in the U.S.

Kulish called on the RBA to do more to anchor inflation expectations, noting the Reserve’s latest communications following the March 18-19 meeting were likely too dovish. (See MNI RBA WATCH: Bullock Stresses Data, Switches To Neutral Tone)

Higher rates and a tougher stance were probably needed as 0% real rates ran the risk that any further external shock will see higher inflation for longer than the RBA wanted, he added.

"This is basic macro economics, if you have inflation over target and employment below the natural rate, the right thing to do is tighten policy. The RBA hasn't been using that narrative. It has talked about preserving job gains as if magically the natural rate of unemployment will be lower but inflation will come down. That to me is somewhat worrying."

Unemployment rose to 3.8% in March, lower than the market’s 3.9% prediction, but up from the prior month’s 3.7%, while employment fell by 6,600, data from the Australian Bureau of Statistics revealed Thursday. MNI has reported the RBA will aim to look through volatile employment. (See MNI POLICY: RBA To Look Past Volatile Labour Data)

The RBA will next meet May 6-7.