More macroprudential imminent?

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From APRA head Wayne Byers today in parliament:

I will just start with a short statement of a few key issues currently on APRA’s plate.

Before I do, however, it’s important to note that Australia continues to benefit from a financial system that is fundamentally sound. That is not to say there are not challenges and problems to be addressed. However, as I’ve said elsewhere, to the extent we’re grappling with current issues and policy questions, they don’t reflect an impaired system that needs urgent remedial attention, but rather a desire to make the system stronger and more resilient while it is in good shape to do so.

The main policy item we have on our agenda in 2017 is the first recommendation of the Financial System Inquiry (FSI): that we should set capital standards so that the capital ratios of our deposit-takers are ‘unquestionably strong.’ We had held off taking action on this until the work by the Basel Committee on the international bank capital regime had been completed. But delays to the work in Basel mean we don’t think we should wait any longer.

Our goal in implementing the FSI’s recommendation is to enhance the capital framework for deposit-takers to achieve not only greater resilience, but also increased flexibility and transparency. And in doing all this, we will also be working to enable affected institutions to adjust to any policy changes in an orderly manner. If we achieve our goals, we will not only deliver improved safety and stability within the financial system, we will also aid other important considerations such as competition and efficiency.

We have many supervisory challenges at present, but there is no doubt that monitoring conditions in the Australian housing market remains high on our priority list. We have lifted our supervisory intensity in a number of ways, including reinforcing stronger lending standards and seeking in particular to moderate the rapid growth in lending to investors. These efforts have had the desired impact: we can be more confident in the conservatism of mortgage lending decisions today relative to a few years ago, and lending to investors was running at double digit rates of growth but has since come back into single figures.

However, strong competitive pressures are producing higher rates of lending growth again. This is occurring at a time when household debt levels are already high and household income growth is subdued. The cost of housing finance is also more likely to rise than fall. We therefore see no room for complacency, and mortgage lending will inevitably remain a very important issue for us for the foreseeable future.

The final issue I wanted to mention is our work on superannuation governance. This is an area where we remain keen to lift the bar. There are some excellent examples of good practice governance in the superannuation sector, but equally there are examples where we think more can be done to make sure members’ interests are paramount. Late last year, we finalised some changes to our prudential requirements to strengthen governance frameworks. The changes we implemented were relatively uncontroversial at the time, and have largely been included within the principles for sound governance that have subsequently been generated by the industry itself.

Bill Evans sees more MP coming:

The Reserve Bank Board meets next week on March 7. We can be certain that the decision from the Board will be to hold rates steady. Recall the comments from the Governor in his answer to a question during his appearance before the House of Representatives Standing Committee on Economics, “At the moment the market pricing is for interest rates to be constant right through this year. That seems a reasonable proposition to me…. The central scenario of a period of stability of interest rates is quite reasonable to me.” Now we have never framed our

We can be certain that the decision from the Board will be to hold rates steady. Recall the comments from the Governor in his answer to a question during his appearance before the House of Representatives Standing Committee on Economics, “At the moment the market pricing is for interest rates to be constant right through this year. That seems a reasonable proposition to me…. The central scenario of a period of stability of interest rates is quite reasonable to me.” Now we have never framed our

Now we have never framed our medium term forecasts around the views of the Reserve Bank – after all they are only “mortal” forecasters like the rest of us . Their forecasts can go awry and policy can change accordingly. But for the immediate future ( like next week) we can take the Governor’s views as definitive. Our view since the rate cut in May last year has always been

Our view since the rate cut in May last year has always been for a follow up move in August and the steady rates throughout the remainder of 2016 , 2017 and 2018. We assess that at least the Governor currently has that view for 2017 but has not commented on the market implied two rate hikes in 2018. His growth forecast in 2018 is 2.75%-3.75%% (down from 3-4%) well above our forecast of around 2.5% (with downside risks). Achieving the RBA’s growth forecast in 2018 might be consistent with market pricing but, certainly, our forecast for a slowdown in 2018 is not consistent with rate hikes – below trend growth signals steady rates at best. In his comments to the

We assess that at least the Governor currently has that view for 2017 but has not commented on the market implied two rate hikes in 2018. His growth forecast in 2018 is 2.75%-3.75%% (down from 3-4%) well above our forecast of around 2.5% (with downside risks). Achieving the RBA’s growth forecast in 2018 might be consistent with market pricing but, certainly, our forecast for a slowdown in 2018 is not consistent with rate hikes – below trend growth signals steady rates at best. In his comments to the

His growth forecast in 2018 is 2.75%-3.75%% (down from 3-4%) well above our forecast of around 2.5% (with downside risks). Achieving the RBA’s growth forecast in 2018 might be consistent with market pricing but, certainly, our forecast for a slowdown in 2018 is not consistent with rate hikes – below trend growth signals steady rates at best.

In his comments to the House the Governor considers the case for rate cuts in 2017. He points out that inflation is below the target range ( “a bit low”) and the unemployment rate is “a bit high”. We would assess full employment at around 5% so, at 5.8%, there is clear excess capacity in the labour market. Of course, that spare capacity is further emphasised in the latest wages report which showed wages growth at a record low of 1.8%. However, his clear problem with leaning further on interest rates is “The main effect (of a rate cut) would be more borrowing for housing, pushing up house prices…”. His concerns with the impact of rate cuts on the housing market are well based.

Consider figures 1 and 2.

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Figure 1 shows recent trends in house prices in Australia. The recent periods of rate cuts (first half of 2015 – February and May) and second half of 2016 (rate cuts in May and August) are associated with significant increases in house price inflation. However, note the trends in the intervening period.These will not be lost on the Governor. During the period (second half of 2015) when the Bank and APRA imposed

During the period (second half of 2015) when the Bank and APRA imposed macro prudential guidelines to slow the pace of lending to investors the pace of house price inflation (national) slowed from 13.7% (six month annualised to August 2015) to zero (6 month annualised to March 2016). In response to the May and August rate cuts house price inflation has lifted to 10% (6 month annualised to February 2017).

Figure 2 shows a similar trend for new lending for housing (key to Governor’s concerns about rate cuts just boosting household debt). In response to the rate cuts in 2015 new lending for housing peaked at $26.8 billion in August 2015 . It subsequently slowed to $23.8 billion by January 2016 (down 11%) only to pick up to $27.1 billion (up 14%) by December 2016 in response to the May and August rate cuts. The conclusion that the Bank would have reached is that macro prudential policies do work and rate cuts stimulate prices and credit despite rates being so low. Little wonder that the Governor noted at the Hearing when referring to recent macro prudential policies, “For us, that is a first order thing that we can do to limit the growth rate of investor credit and, I think, that has been a successful public policy intervention.”

I assess that, given that both Sydney and Melbourne prices are up 14% (six month annualised – Core Logic data) the Bank and APRA may be considering even tighter macro prudential policies. It is not only inflation and the unemployment rate that would be of concern to the Reserve Bank. Throughout the

It is not only inflation and the unemployment rate that would be of concern to the Reserve Bank. Throughout the Hearing he indicated a preference for a lower Australian dollar. He accepts that the AUD is probably around fair value but questioned the

Throughout the Hearing he indicated a preference for a lower Australian dollar. He accepts that the AUD is probably around fair value but questioned the feed-back to activity from higher commodity prices with miners apparently reluctant to increase capacity and wage pressures in the sector continuing to ease.

He has also adopted a more conservative attitude to the consumer, expecting that the recent falls in the savings rate are unlikely to be sustained.

Most of this “mood” does not sit well with the expectation that growth will lift in 2018, particularly in the face of a downturn in residential construction. His “faith” that non mining investment will lift to reflect tightening capacity utilisation is not convincing particularly with the higher AUD and a more cautious consumer.

Overall we saw little in the comments at the Hearing to sway our expectation of a slowing economy in 2018. If, as we expect, the Bank will get around to adopting additional macro prudential policies to slow housing in the second half of 2017 the stage will be set for another year of steady rates in 2018.

With the economy slowing and macro prudential policies further tightening housing markets, the risks to rates in 2018 will be to the downside rather the upside as currently expected by markets.

I get very frustrated with the glacial pace of APRA but there is no denying the policy logic here. Even so, the timid regulator will probably wait until after the Budget to see what happens.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.