Chris Iggo

Why financial markets need not worry about inflation, for now

Central banks will not withdraw monetary policy support until inflation rises above 2 per cent for a sustained period. While a modest increase in inflation is to be expected, it is unlikely to be enough to push interest rates higher for some years to come

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Shoppers stock up on provisions at a Walmart store, in New Jersey, in July 2020. There is a lot of pent-up demand in the household and business sectors which should support spending once infection rates are lower. Photo: Reuters

Chris Iggo

Published: 3:30am, 11 Feb 2021Updated: 4:02am, 11 Feb 2021

On February 2, the Reserve Bank of Australia announced that it was maintaining its key interest rate target at 0.1 per cent and that it would extend its purchases of bonds by another A$100 billion (US$76.8 billion). It said it would not raise interest rates until inflation is comfortably between 2 and 3 per cent (it is currently less than 1 per cent). In no uncertain terms, the central bank argued that this is unlikely before 2024.

Australia faces an economic outlook common to many countries. Activity has been ravaged by the coronavirus pandemic, unemployment has risen, and spare capacity has emerged. However, the outlook is improving. Scientists have done an incredible job of delivering effective vaccines against Covid-19 that should bring down infection rates and reduce health risks.

That means a reopening of economies and a recovery in growth. China provides a road map in this respect. By the end of 2020, China’s fourth-quarter GDP growth rate had reached a level close to its medium-term target of 6 per cent per year. Current forecasts are for growth in the US and Europe to surge in the second half of 2020.

There is a lot of pent-up demand in the household and business sectors which should support spending once infection rates are lower.

Central banks aren’t going to be rushed into removing monetary policy support. Indeed, the message from the US Federal Reserve and the European Central Bank is like that from Australia – inflation needs to be consistently higher before interest rates are increased.

That is good news for borrowers, and it means governments can continue to pursue aggressive fiscal spending to support the recovery without financial markets getting concerned about the cost of borrowing.