Australia's central bank expects the economy to recovery quickly from a deep pandemic-induced contraction last quarter, while having to lift its outlook for inflation as global supply pressures have a greater impact than first thought.
In a quarterly round up of the economy, the Reserve Bank of Australia (RBA) conceded inflation had returned to its 2-3% target band a full two years earlier than expected, forcing it to abandon a commitment to keeping bond yields super-low.
Policy makers also walked back on projections that interest rates would not rise until 2024, saying a hike in 2023 was now plausible given the economy was on the road to recovery.
While coronavirus lockdowns saw activity shrink sharply in the third quarter, world-beating vaccination rates have since allowed the economy to reopen and consumption has roared back.
"A rapid bounce back in domestic demand is forecast in the December and March quarters as restrictions are further eased," the RBA said in its 71-page report.
It now sees gross domestic product (GDP) at an annual 3% by the end of this year, down from 4% previously, but boosted 2022 by more than a percentage point to a heady 5.5%.
The path for core inflation has been lifted markedly so it now sits at 2.25% for the end of this year, up from a previous prediction of just 1.75%. Yet, further progress is seen as gradual so that inflation only reaches 2.5% by the end of 2023.
Crucial to that outlook is wages growth, which has lagged badly for years and held inflation below target. The RBA argues wages need to grow at an annual 3% or more to keep inflation in the target band, but it only expects to reach that in late 2023.
It was this restrained forecast that led RBA Governor Philip Lowe to say a rate rise next year was "extremely unlikely", even though financial markets are pricing a move as early as July.
Indeed, futures and swaps imply the current 0.1% cash rate will be approaching 1.0% by the end of 2022, and 1.5% at end 2023.
Aggressive pricing
Markets have moved aggressively in recent weeks to price in tightening across the developed world, leading many policy makers to push back on the trend.
The Bank of England on Thursday stunned investors by skipping a chance to hike rates, while the European Central Bank was actively talking down expectations.
The resulting rally in global bonds spilled over into Australia debt and three-year yields <AU3YT=RR> dived to 0.88%, reversing some of the recent dizzying spike to 1.257%.
The market remains vulnerable to any upside surprises in domestic economic data, in particular the third-quarter wages report on Nov. 17 where a strong figure would threaten to upend the RBA's measured outlook.
David Plank, head of Australian economics at ANZ, believes the risks are to the high side.
"Rising inflation expectations, even greater competition for labor and the potential for a so called Great Resignation in Australia should see wages growth accelerate through 2022, to just above 3% y/y by the end of the year," he argues.
"Adding this to the stronger global inflation pulse means we now see inflation lifting to 2.5% in Q1, 2023," he added "This will be the trigger for the RBA to tighten."
He tips a first hike for May 2023, and two more by the end of the year.