It’s the debt, stupid

The more I think about it, the more important today’s speech by Rick Battelino becomes. It’s not that there was anything new in the speech. It was a reiteration of the RBA’s relatively new credit-conservative doctrine. More importantly, it was delivered by its most (formerly) credit-bullish governor.

Rates discussion tomorrow will be dominated by the CPI number. That’s only natural for two reasons. The first is that inflation has been the RBA’s boogieman all year so everyone is focused on watching its pace of decline.

But the second reason is just as important, if not so obvious. It is that much of the discussion is driven by bank economists and they are not in a position to fathom the RBA’s full message: that it is satisfied with current (historically subdued) levels of credit growth.

Let’s think back to the beginning of this business cycle. It commenced with Glenn Stevens’ unprecedented appearance on Channel Seven’s Sunrise program in which he warned of the dangers of housing speculation.

Next, mid year, in a very important speech, the governor said:

The big rise in debt in the past couple of decades has been in the household sector. There have been many reasons for that and, overwhelmingly, households have serviced the higher debt levels very well. The arrears rates on mortgages, for example, remain very low by global standards. As a result the asset quality of financial institutions has remained very good. So, to be clear, my message is not that this has been a terrible thing.

But that doesn’t mean it would be wise for that build-up in household leverage to continue unabated over the years ahead. One would have to think that, however well households have coped with the events of recent years, furtherbig increases in indebtedness could increase their vulnerability to shocks – such as a fall in income – to a greater extent than would be prudent.

Of course, throughout last year and 2011, the RBA also consistently bashed up consumers with the same message. If you borrow and spend, we will punish you with higher interest rates.

Now, we’ve had a big adjustment going on in the economy over this period. The resource boom mark II did push the economy towards capacity and threaten an inflationary breakout. But ultimately, it was held in check by another adjustment that we don’t like to talk about too much. That’s the “the great disleveraging“. The effort by the RBA to backfill the housing bubble by reducing the rate of credit growth (and by extension house prices).

So, with these two adjustment’s in our minds, let’s revisit Rick Battelino’s speech from yesterday:

After a 10–15 year period during which households increased their gearing and reduced their rate of saving, they have returned to a more conservative, and traditional, pattern of financial behaviour. Household credit growth has slowed to a rate in keeping with, or slightly below, the growth in household incomes;  the saving rate has increased to a level that is more normal based on history;  and household spending growth has slowed from a rate that substantially exceeded household income growth, to one that, over the past year, has been broadly in line with income growth. Within total consumer spending, there appears to have been a shift away from spending on goods in stores to spending on services, particularly services such as overseas travel, eating out and entertainment. As a result, retail sales have been particularly weak.

This adjustment in consumer behaviour has created a difficult trading environment for some businesses, coming as it has after a prolonged boom. But the adjustment in Australia has been benign compared with the adjustments in household finances and housing markets elsewhere in the world, and it has put household spending and financing on a more sustainable path. This will ultimately benefit the health of the economy. (my bolding)

That really is an admission that we are having to undergo the same process of adjustment in our private debt that is afflicting every other Western nation. It is benign only because the second adjustment happened along: the mining boom.

So, what relevance does that have to today’s CPI number? Well, take a look at what the RBA said in it’s last meeting:

Taking into account all the recent information, the path for inflation may now be more consistent with the2–3 per cent target in 2012 and 2013, abstracting from the impact of the carbon pricing scheme. This assessment will be reviewed on receipt of further data on prices ahead of the Board’s next meeting. An improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.

So, there are two conditions for a rate cut, not one. Falling inflation is the first. The second is falling demand.

And, back to yesterday’s Battelino speech:

Total final demand grew by 3.4 per cent over the year to June, which is about in line with past trends. That, however, has not translated to trend growth in GDP, as the high exchange rate and the high import content of some mining investment have seen an increased proportion of demand being met from imports, rather than domestic production. The weather-related disruptions to coal exports added to the shortfall in production. In this environment, employment growth slowed noticeably in the first half of the year, and around the middle of the year there was some rise in unemployment.

…Recently, there has been some easing in financial conditions following the fall in market interest rates that has accompanied the financial volatility. Banks have passed through to borrowers notable declines in interest rates on term housing loans and some business loans, as their cost of funds has declined. Increased competition among banks in response to the increased availability of deposits and relatively subdued demand for loans, has also resulted in some shaving of interest rates on standard variable mortgage loans for new borrowers. As a result, the interest rates on new loans are now around 10–15 basis points lower than they were early in the year. The modest net fall in the exchange rate in recent months has also, to some extent, reduced pressures on some sectors of the economy.

In sum, that does not look like a summary of falling to demand to me.

So, if that’s true, what would we need to see for a rate cut? If credit growth weakened further and house price falls accelerated that would qualify. If the iron ore and coking coal prices continued to fall, that would also qualify on reduced national income and a flow through to reduced national investment.

You get he picture anyways, we’re not there yet.


  1. Sounds reasonable to me. Soon they will be able to claim no rate changes for a year – stability plus. And if nothing else, it is stability that is sought.

    • I’m very much hoping rates stay the same for at least another 12 months. It seems to be taking the heat out of the housing market in a fairly orderly manner thus far (as HnH has alluded to, this could be one of the RBA’s primary goals at this point)

  2. Yes! That is the vibe my electroreceptors are picking up.

    But following the ‘playpus’ speech I am not holding my breath for any concessions that there are ‘numerical’ measures capable of indicating whether some leaning against credit growth using interest rates is appropriate.

    That is still purely the domain of electroreception.

    Possibly because it would not be hard to apply such measures against past interest rate decisions.

  3. Exactly. The RBA think that current household behaviour is “normal” by historical standards, and they like it. Savings are growing, debt and consumption are expanding in line with income. Demand is growing (even though not all is expressed in the domestic economy) at its historical trend. So far, so good.

  4. This makes me think that in terms of securing off shore funding for the banks next year, it probably looks good to have a policy that restrains the growth of credit fuelled assets.

    If loans with just 10 % deposits are still offered for FHBs in the current market, I sure hope the potential buyers are not pressured or encouraged into this market right now by their kind relatives and friends… Otherwise next year may really be ugly and sad.

  5. Sounds like this the RBA trying to manage a soft landing for the non-mining part of the economy – Rates low enough that people can afford to disleverage, but high enough to discourage disproportionate credit growth, the mining income providing the buffer for the economy on a global level, and Jedi economics to swing sentiment a percentage point or two.

  6. I dont know I am not buying it. Once the CPI numbers come out and we see what Europe does this week then Ill make the call. The difference between Australia and the rest of the Western World is the people are still carrying the debt not the govt. What makes me wonder is when the Mining boom is over will this still be the case. The only thing that they may consider to cut it is to bring the dollar down a bit. The high dollar is killing alot of industries.


  7. There may also be a desire to improve Australian Banks funding position through more domestic savings and less international borrowing.

    There may also be a desire to increase the capacity of Australians to fund both debt and equity for the forecast resources investment boom, rather than relying on more overseas debt and investment.

    I suspect that the RBA will not lower rates too much until it is clear that inflation is falling below the target range, even though the high currency is reducing the profitability of import competing sectors and inbound tourism and Building approvals 12 month moving average has already fallen significantly and continues to trend down.