History points to the risk of tight monetary policy
Past rate hike cycles have seen tight monetary policy to control inflation.
One way central banks judge whether they have done enough on monetary policy to return inflation to target is to compare the current policy rate with the neutral policy rate.
The neutral policy rate can be thought of as the interest rate that would prevail if underlying inflation was in line with the central bank's target, output was in line with its potential, and there was full employment in the labour market.
Faced with high inflation, central banks need tight monetary policy, with a policy rate higher than the neutral rate required to slow the economy and bring prices under control.
Unfortunately the neutral policy rate is unobservable and has to be estimated by relying on techniques that extract the neutral rate from market pricing, economic models and/or surveys.
The RBA calculates the neutral cash rate by taking the average of estimates derived from nine different methods, which allows the neutral rate to vary over time.
As at early last year, the RBA put the neutral cash rate at about 1% in real terms, which, allowing for the 2½% midpoint of the inflation target, translated to a 3½% nominal neutral cash rate.
Sidestepping the replication of the nine methods that underpin the RBA's calculations, the average neutral cash rate can be approximated in a timely way by using a simple model based on real bond yields.
This simple model suggests that the neutral real rate picked up further around the middle of last year and currently stands at about 1¼%, which implies a 3¾% nominal neutral cash rate, again allowing for the 2½% midpoint of the target band.
Encouragingly, this lines up with Freedom of Information documents that show that the RBA recently raised its estimate of the neutral nominal cash rate from 3.5% to 3.8%.
Mindful that there is significant uncertainty around any estimate of the neutral rate, this suggests that monetary policy is finally slightly tight (assuming that inflation expectations remain anchored by the inflation target), with the current cash rate of 4.1% slightly above the neutral nominal cash rate of 3.8%.
However, history shows that the RBA has needed to have tight monetary policy in order to contain inflation, which points to upside risks to the current cash rate.
That is, monetary policy has been much more restrictive during past tightening cycles, with a 2pp median of the peak in the cash rate relative to the neutral rate in the five hiking cycles since the late 1980s.
Never miss an update
Enjoy this wire? Hit the ‘like’ button to let us know.
Stay up to date with my current content by
following me below and you’ll be notified every time I post a wire
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
........
Investment Disclaimer
Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting www.coolabahcapital.com. Neither Coolabah Capital Investments Pty Ltd, Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Investments (Retail) Pty Limited (CCIR) (ACN 153 555 867) is an authorised representative (#000414337) of Coolabah Capital Institutional Investments Pty Ltd (CCII) (AFSL 482238). Both CCIR and CCII are wholly owned subsidiaries of Coolabah Capital Investments Pty Ltd. Equity Trustees Ltd (AFSL 240975) is the Responsible Entity for these funds. Equity Trustees Ltd is a subsidiary of EQT Holdings Limited (ACN 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT).
Forward-Looking Disclaimer
This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.
3 topics
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Comments
Comments
Sign In or Join Free to comment
most popular
Equities
Why "buy and manage" is the better way to invest in stocks
Livewire Markets
