Incoming RBA governor Bullock warns climate change might light fire under interest rates, markets and AUD rate largely unaffected

Speaking at the Australian National University in Canberra, the incoming Governor of the Reserve Bank of Australia (RBA), Michele Bullock, warned that climate change was likely to lead to greater volatility in inflation, while making it harder to judge the right level of interest rates, adding further uncertainty to future policy.

"These climate risks will affect the economy through several channels," she said in her last speech as Deputy RBA Governor.

"Hotter temperatures and more extreme weather will disrupt businesses, damage property and lower productivity growth. Actions taken to reduce emissions may present adjustment costs, but they will also present opportunities. […] Indeed, while there is much uncertainty in this area, there is general agreement that a timely and orderly transition will be the less costly approach in the long run."

The RBA has raised interest rates by 400 basis points to an 11-year high of 4.1% in a bid to tame runaway inflation but has now paused for the second month in a row to avoid advancing an overly restrictive policy stance.

During the question-and-answer session, Bullock, who will become governor in mid-September, said rates may need to rise again as inflation is still too high, adding that policy would depend on the data, largely repeating the bank's recent guidance.

“All I can say is that we may have to raise interest rates again but we’re watching the data very carefully, and we will be taking decisions for the time being until next year at least month by month,” Bullock said.

Market reactions to Bullock’s speech: Mixed takes from experts, AUD reaction timid

As of 11 a.m. EDT, the Australian dollar has grown by close to 0.3% against the US dollar (AUD/USD), trading around the 0.645 mark, indicating a timid reaction to the speech. Over the past year, the Aussie has shed close to 6% of its value against the greenback, as per Marketwatch data, indicating that the hawkish Federal Reserve exerts stronger influence on the currency pair.

Another popular AUD-based currency pair — the Australian dollar and the New Zealand dollar (AUD/NZD) — dipped by close to 0.2% following the news, trading at around 1.085 as of 11 a.m. EDT.

Reactions to the speech among experts were varied, with Markets.com Chief Market Analyst Neil Wilson issuing a stern reaction to Bullock’s address, highlighting the potentially speculative nature of the link between climate change and higher interest rates:

“Here’s a good one: climate change will lead to more volatile inflation outcomes; extreme weather could raise inflation; and the impact of climate change on the neutral rate is not clear cut. So says the RBA’s incoming governor Bullock – get those punches in early, I suppose. We know the agenda. I need not explain why tying monetary policy to climate change and the green agenda is absurd. Suggesting it ‘could’ raise inflation is a very subjective line to take and hardly one that economists could argue with any certainty. It’s a political line. The CB is supposed to be independent of politics. She may as well as say ‘Higher for longer, poorer for longer, peasants’.”

However, there may be credence to Bullock’s claims, as noted by The Sydney Morning Herald’s Shane Wright:

“Research released on Tuesday by economists at JPMorgan suggested an El Niño weather event could add around 0.3 percentage points to Australia’s inflation rate through 2024 via higher prices for fruit, vegetables, dairy products and meat.”

The Globe and Mail, one of Canada’s leading publications, added that “markets have priced out almost any chance of a rate hike at the RBA’s September meeting next week, and around a 60% probability that the tightening cycle was over.”

AUD/USD exchange rate: All eyes on Wednesday CPI announcement

On Wednesday, the 30th of August, Australia's Monthly Consumer Price Index (CPI) will be released. It is expected to come in at 5.2%, down from the previous reading of 5.4%.

The market understanding of inflation indicators is that higher inflation leads to higher interest rate expectations and a stronger local currency, indicating that the Australian dollar may show gains against the USD in case of a surprise CPI reading.

As explained by FXStreet analyst Valeria Bednarik:

“Softer-than-anticipated inflation figures would reinforce the idea the RBA will stand pat. In an ideal scenario, that would put pressure on AUD/USD. Still, easing price pressures will also mean the Australian economy could dodge an economic setback and trigger optimism, sending AUD/USD in the opposite direction.

However, if the monthly CPI comes higher than anticipated, financial markets could lift bets for a rate hike as soon as September. The AUD/USD pair could surge as an immediate reaction to the news, but it can have a hard time holding on to such gains, particularly if market sentiment remains sour.”

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