When the Reserve Bank of Australia took the plunge on Monday and became the first G20 central bank to raise interest rates since the global downturn began, it triggered big gains for equity markets around the globe. The move was seen by many as further evidence that the global economy was recovering from recession.
But was that the correct reading of the RBA’s decision? Not, according, to Morgan Stanley’s Joachim Fels:
The RBA’s move holds an interesting lesson that is worth keeping in mind when thinking about other central banks’ prospective behaviour in the upcoming tightening cycle: strongly rising asset prices may induce central banks to start lifting rates early from record-low emergency levels even if growth is still below-trend and inflation below-target. The RBA expects growth to return to trend next year, and also remarks that “dwelling prices have risen appreciably over the past six months”.
And the RBA is not the only central bank concerned about the impact unorthodox monetary policy is having on asset prices.
Over to Mr Fels again:
On the opposite corner of the globe, Norway’s Norges Bank is even more articulate in its concern about house prices. In an important speech last week, Governor Gjedrem stated that “house prices in Norway have risen sharply and probably excessively”.
Unsurprisingly, Morgan Stanley thinks Norway’s central bank will be the next to hike, with a 50bps on October 28.
Australia and Norway can, of course, afford to worry about asset prices since they have been least affected by the global crisis. However, at some point other central banks will have to address the question of runaway asset price inflation.
And that date is drawing ever close say Fels:
Sometime in the new year, if risky assets keep feasting on the liquidity glut, equity and house prices could come into focus as runaway asset price inflation creates a dilemma for central banks: hiking into a weak economy could stall or even reverse the recovery; but staying on hold for too long would risk inflating the next bubble. With the ‘mop up after the bubble bursts’ orthodoxy having fallen victim to the crisis, at the very least the risk exists that central bankers will be forced to sound hawkish — even if not ‘leaning against the wind’ outright.
You have been warned.
Related links:
The interest rate disconnect – FT Alphaville
BoE holds interest rates, leaves QE unchanged – FT Alphaville
Eurozone interest rates left on hold – FT
UK interest rates – as expected – Money Supply