Goldman and JPMorgan Square Off in Australia's Rate Call Battle

(Bloomberg) -- In one corner is Goldman Sachs Group Inc. predicting Australian property prices and household debt spiraling ever higher will prompt the central bank to raise interest rates this year.

In the other is JPMorgan Chase & Co. expecting regulators to come down harder with macro-prudential measures that would help slow house-price growth and allow the Reserve Bank of Australia to reduce interest rates this year to lower unemployment and boost inflation.

In the middle lies an emerging consensus that thinks RBA Governor Philip Lowe will sit on his hands through 2017, and in the case of a couple of veterans like Westpac Banking Corp.'s Bill Evans, all of next year as well. Their expectation is that the Sydney and Melbourne property markets will peter out as long as there's no further fuel from policy easing and that household debt will then stabilize.

Economic growth will have strengthened and wages and inflation passed their period of weakness, the status quo camp argue. The improved global backdrop of growth only adds to reasons for the RBA to keep a steady hand.

Goldman's Call

Defying the consensus, Goldman Sachs came out Wednesday with a research report revising its already hawkish forecast for a rate increase in February 2018 by bringing it forward to November, and ascribing this scenario a 60 percent probability. Economists Andrew Boak and Bill Zu's argument runs off Lowe's own words as a younger central banker when he theorized on using higher interest rates to help contain financial excesses.

Goldman senses skepticism in the RBA toward macro-prudential policies -- or at least frustration the current supervisory measures aren't doing enough. Boak and Zu also point to the governor's decision to elevate financial stability considerations in policy decisions and his willingness to tolerate lower inflation -- encapsulated in his line that the RBA “are not inflation nutters.”

With Sydney property prices up 105 percent since 2009 and having recently re-accelerated, together with increased speculative activity to jump 18.4 percent year-on-year, there's a problem to confront.

Goldman cite this quote from Lowe's research history going back to the early 2000s: 

A “central bank might opt for higher interest rates than are justified simply on the basis of the short-term inflation outlook if there are clear signs of imbalances, such as if credit growth is rapid and asset prices are rising quickly. The justification for doing so could be that the higher interest rates could help contain the financial excesses, and in doing so reduce the probability of future financial instability and possibly a sustained undershooting of the inflation objective.”

After the quarter percentage point hike forecast for November, Goldman sees two more in 2018 and then three more increases after that to bring the policy rate to 3 percent by 2020.

JPMorgan's View

JPMorgan, on the other hand, noted after Tuesday's policy statement that the RBA's confidence in the supervisory measures for property lending seems to have been shaken.
With the labor market a long way from full employment and core inflation unlikely to reach even the bottom of the RBA's 2 percent to 3 percent target for the next two years, rate hikes are off the table, it says.

The RBA's concern about the effectiveness of the macro-prudential policies may herald an intensification of the measures, according to Sally Auld, JPMorgan's head of fixed-income and currency strategy for Australia. Without tougher measures, it's almost impossible to see the RBA cutting interest rates further. JPMorgan forecasts regulators will do so and the RBA will probably ease in the third and fourth quarters to a rate of 1 percent.

At a market level, the chances of policy easing this year have fallen to less than 5 percent while pricing for an increase has reached about 40 percent for December. Yet at the same time, there are some top names still calling for easing: among them are Macquarie Bank Ltd., National Australia Bank Ltd., Royal Bank of Canada and Morgan Stanley. Only Annette Beacher at TD Securities is also forecasting a hike.

Among Australia's pool of about 30 market economists, bragging rights are up for grabs when interest-rate forecasts splinter. In 2017's Goldman vs JPMorgan face off, there can be only one winner.

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net.

To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Malcolm Scott