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Analysis:  Why don’t markets believe the RBA? 

• The RBA meets tomorrow amid an international context that sees central banks increasingly concerned current inflationary pressures might be more persistent and the US FOMC set to debate an even faster tapering of QE.
• The RBA will be pleased about the smaller hit to activity in Q3 and the bounce back in spending and employment to date in Q4. Omicron is a new uncertainty, which will take a few more weeks to get greater clarity on, however the early indications are tentatively positive in regards to health effects being ‘milder’ than prior variants.
• Today’s Weekly examines why markets are pricing a completely different outlook for interest rates than current guidance by the RBA. The most likely explanation for this is markets simply do not believe the RBA’s inflation and wages forecasts, which as recently as last quarter characterised both variables considerably lower than turned out to be the case in Q3 readings.
• That said, there’s still some way to go to see wages back to 3%, though the rebound in labour demand suggests an early resumption of the declining trend for unemployment is likely ahead of the pick-up in foreign-sourced labour once borders reopen.
• It’s also worth considering how markets might be right on the interest rate outlook. Seven interest rate increases by this time in 2023 would likely require economic growth to remain very strong, the unemployment rate to continue to decline quickly and wages to strengthen. While that’s possible, the degree priced seems unlikely, though an earlier start to RBA tightening than the RBA has been signalling continues to be very likely and with global inflationary pressures persisting, markets will continue to price against the RBA.

Chart 1: Can market pricing be correct?

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