Australia Viewpoint: The Quiet Tightening

Research evidence excerpt

Australia Viewpoint: The Quiet Tightening

Same cash rate, tighter stance as short-run neutral falls

Monetary policy operates through both the level of the cash rate and broader financial

conditions, with the latter determining how restrictive a given stance is in practice.

Financial conditions capture the cost and availability of finance for households and

businesses, as well as asset prices and the AUD. A given cash rate can become more or

less restrictive over time as financial conditions evolve. While the cash rate anchors the

stance of policy, it is the transmission through expectations, borrowing rates, credit

availability, asset prices and the exchange rate that ultimately shapes demand.

Financial conditions are key to assessing the difference between the long- and short-run

neutral rates that are most relevant for monetary policy. As RBA Assistant Governor

Christopher Kent has emphasized1, the long-run neutral rate is shaped by slow moving

structural forces, while the short-run neutral rate is more cyclical and can deviate from

the long-run estimate in response to shocks, fiscal policy, and changes in financial

conditions independent of the cash rate. We estimate the long run nominal neutral rate

is around 3.5%, while the short-run neutral rate is likely closer to 4%, but set to decline

through 2026 and 2027.

Exhibit 1: The yield curve has shifted up relative to the most recent Exhibit 2: Real cash rate expected to rise 120bps by mid-2027

hiking cycle peak Real cash rate (ex post)

3-year and 10-year government bond yields (%)

5.5

Cash rate at 4.35%

4.5

3.5 -3

-6

2.5 1992 1997 2002 2007 2012 2017 2022 2027

2023 2024 2025 2026 Real cash rate BofA forecast

AUD 3y AUD 10y Source: RBA, BofA Global Research. Note: Real cash rate uses trimmed mean inflation and BofA