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Australia’s central bank is likely to gently rein in some of its emergency stimulus to reflect the economy’s powerful recovery, even with the nation’s largest city in lockdown due to an outbreak of the delta variant of Covid-19.

The Reserve Bank is expected to decide against rolling over its three-year yield target to the November 2024 bond from the current April 2024 at Tuesday’s meeting, an extension that would imply interest rates won’t go up until 2025.

The central bank will also maintain its quantitative easing program but likely in a revised form, with most economists expecting it to come up with a more flexible approach than the first two tranches of A$100 billion ($75 billion) each.

Those moves would show there is an ultimate finish line for record low interest rates while continuing support for the economy to ensure the recovery is lasting.

“Clearly the current Covid situation will be front-and-center of discussion,” said Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada. “This will likely see the RBA send a reassuring message which errs a little dovish, even as it opts to not roll the target bond to the Nov-24s and signals some taper in a QE3 program.”

Governor Philip Lowe is determined to stay near the back of the global policy pack — well behind Canada and New Zealand — when it comes to tightening policy as he wants to avoid spurring currency gains. That suggests he’ll be waiting for the Federal Reserve to move, despite local unemployment tumbling to 5.1% and all jobs and output lost during the pandemic now recovered.

Against the backdrop of such a strong recovery, the latest Covid outbreak offers a timely reminder that uncertainties remain, offering Lowe more justification for sticking with a dovish line.

Markets are currently pricing in the first interest-rate increase in late 2022 and economists expectations range from November 2022 for Gareth Aird at Commonwealth Bank of Australia, the nation’s largest lender, to 2025 for Phil Odonaghoe at Deutsche Bank AG. The consensus falls in 2023.

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Lowe is aiming to drive the economy to maximum employment to push wage growth above 3% and rekindle dormant inflation, which the central bank aims to keep between 2-3%. The real debate then is how quickly the tightening of the labor market translates into pay gains.

Aird sees that happening quickly, given the large number of job vacancies and the likelihood that borders remain closed given the sluggish nature of Australia’s vaccine roll out. Others are less sure.

What Bloomberg Economics Says…

“An outflow of temporary workers has distorted Australia’s labor market indicators. Had these temporary visa holders remained in Australia, we estimate the unemployment rate would be 2.5 percentage points higher, indicating significant potential for a reopening of borders to damp emerging wage pressures.”

— James McIntyre, economist. See full note here

Data Monday showed job advertisements advanced 3% in June for a record streak of 13 consecutive monthly gains.

Inflation Down Under has been weak for a long time. That’s why Canada, whose recovery has arguably been less robust than Australia’s, has a more hawkish central bank — it starts from a better position on consumer-price growth.

Paul Bloxham at HSBC Holdings Plc notes that inflation has averaged 1.5% in the almost five years Lowe has been at the helm. In contrast, his two predecessors completed their 10 years respectively at exactly 2.5%.

Bloxham estimates that for CPI to average 2.5% over Lowe’s seven-year term, it would need to run at 4.1% through to September 2023. If he were to stay on for 10 years, it would need to average 3.2%.

“So why is the governor so dovish?” Bloxham asks. “Well, because he would much prefer 3-4% inflation over the next couple of years to 1-2% inflation.”

In contrast to pre-pandemic times, Lowe also has the government helping this time. Treasurer Josh Frydenberg, likely with half an eye on an election due by May next year, maintained high spending in the May budget. That means more bond issuance.

QE Debate

The RBA has already said it will keep its QE bond-buying program going beyond September. Economists see a third round ranging from A$50 billion of purchases over six months to a further A$100 billion. Another option is to keep it at A$5 billion a week — as at present — but with regular reviews and no total set figure.

Whatever Lowe and his board decide, they will need to balance an array of competing factors: data that have consistently exceeded the central bank’s forecasts, a virulent strain of the coronavirus that’s forced renewed lockdowns and technical factors in the markets.

With the recovery in the economy pulling forward the expected timing of the first RBA rate hike, the RBA can’t roll over the three-year yield target without inverting the short end of the yield curve, said Matthew Peter, chief economist at QIC Ltd.

“However, with the Australian dollar heading towards $0.80 and significant issuance of government debt, the RBA will extend its QE program to provide insurance against an excessive steepening of the yield curve.”

(Updates with record streak of job advertisements in 12th paragraph.)

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