Don’t blink because you might miss it. Today I agree with Chris Joye:
Does cutting rates in December do anything to solve bank funding problems (only guarantees and liquidity facilities will), and will the banks pass on any cut given the turmoil in overseas funding markets?
I personally think a better policy response is to guarantee, one way or another, bank access to funding, and keep rates stable for the time being. The RBA knows that the ultimate Euro response to all of this could be Eurobonds, debt monetisation, and inflation.
After yesterday’s remarkable construction-work-done data, which trumped market expectations by an order of magnitude and which will individually add about 1.7 percentage points to Q3 real GDP (not annualised), it’s clear the domestic economy is not in the hole that so many pessimists claim. The only rationale for cuts at this stage is the offshore environment. (h/t The Lorax)
Ok, so I don’t agree at all. The domestic economy is not in a hole yet even if it’s growing slowly. But if the European crisis continues and asset price falls do as well, dragging sentiment down with them, then stalled growth in the services economy will overwhelm the isolated pockets of ballistic construction. That was surely the lesson of 2011. The chance that Europe will pour forth inflation is pretty low, though there is a risk it will come from across the Atlantic with QE3.
However, I do agree with CJ that it’s worth thinking about getting out in front of this crisis with bank guarantees rather than rely solely on rate cuts that will have limited impact on the bank’s problems and may distort appropriate settings for the economy more widely.
Consider, assuming the ECB does not print, we can let a credit crunch develop in Australia as funding costs for the banks refuse to fall and rate cuts can’t keep pace. At some point, perhaps before there is even a credit event such as Lehman, the credit ratings agencies will get restive about the Australian banks. As we have seen, they are not the same happy-go-lucky types of 2008, and it’s possible that they will warn about our bank ratings if the guarantee does not appear relatively quickly. Remember what S&P had to say in its recent BICRA downgrade:
In our view, weaknesses for the Australian banking sector are its material dependence on net external borrowings, which fund about 24% of domestic customer loans; and limited support from core customer deposits, which fund only about 38% of domestic customer loans. We consider that these weaknesses are partly offset by a domestic debt capital market that can support the banking sector and the government and central bank, whom we view as responsive and flexible to banks’ funding needs.
We classify the Australian government as being “highly supportive” of the banking system, reflecting our expectation of timely financial support to ensure the stability of the financial system, if needed. This assessment factors in a well-developed administrative and institutional framework that should facilitate a timely and coordinated response, and a track record of proactive and prompt support for the banking system through measures such as guarantees for retail and wholesale funding during the global financial crisis. We believe that the existing legislation, policy, and relationships with supranational agencies do not hinder the Australian government from assisting the banking system.
I ask you, what is timely? Is it better to get out in front? Or wait until it’s a crisis? As we’ve seen elsewhere, once the ratings agencies are involved, it’s very bad for whatever institution that is targeted. Would it be more or less damaging to the bank’s credibility to be guaranteed sooner rather than later? Obviously markets already know about the guarantee. Everybody does. So there’s no new moral hazard. In fact, it could even reduce moral hazard. Come clean, as it were. Instead of all of this cloak and dagger stuff, with dodgy repos, rushed new bonds, clandestine regulatory oversight and opaque accounting for wholesale debts.
But I guess that’s kind of why it won’t happen. To do it openly, and before any other country, risks throwing the bankers onto the pitchforks of the people. And we can’t have that!
