Two RBA speeches this morning confirm that the RBA has sloughed its post-GFC caution, abandoned disleveraging, and is happy now to see a return to yesterday’s borrow and consume economic model.
The first, by Deputy Governor Phil Lowe, is long-winded pat on the back for the RBA in managing the economy through the last few years:
So, somewhat ironically, two of the factors that have created difficult challenges for many businesses over recent years – the high exchange rate and increased household savings – are the very same factors that have been critical to Australia’s good macroeconomic performance. Importantly, these factors have helped Australia to digest a huge investment boom without generating substantial imbalances in the economy. At the same time, these factors have prompted significant structural change which, while difficult, is critical to achieving higher overall productivity and higher living standards.
There is clearly a lot of change going on in the Australian economy at the moment. How you view this change depends critically upon where you stand. However, no matter what one’s perspective, we should not lose sight of the fact that maintaining overall macro balance through this period of change has been a significant achievement. And it is an achievement that has benefited the entire community.
Lowe sees no downsides or imbalances and also reckons manufacturing is adjusting successfully to a new era, though he doesn’t mention that investment in that sector is running considerably below levels first seen in 1989.
For today’s discussion, however, what matters most is the following:
Since November 2011, the Board of the Reserve Bank has lowered the cash rate six times, by a cumulative 1¾ percentage points. These reductions have brought the cash rate down to 3 per cent, which is equal to the lowest level on record. Lending rates have also come down substantially, although a number are still above earlier lows given the general rise in bank funding costs that has occurred since the global financial crisis.
Recently, there has been some discussion as to whether these low rates are actually working. This type of discussion is not surprising given that there are lags between when monetary policy is changed and when the full effect is felt in the economy. It is not a matter of simply changing interest rates today and seeing an immediate response tomorrow. Another complication is that the environment in which interest rates are being adjusted is not the same from one interest rate phase to the next. As a result, the exact way that movements in interest rates are transmitted to the economy can change over time.
All this means that, as always, we need to monitor things very closely. At the moment though, the available evidence does suggest that lower interest rates are doing their work broadly as expected.
In general, the initial responses to a loosening of monetary policy would be expected to include stronger asset prices, improved conditions in the housing market, a lift in consumer confidence and a lower exchange rate.
Much of this does appear to be occurring. Nationwide measures of house prices have increased by around 4 per cent since mid last year, after having declined for around 18 months. Home lending approvals and auction clearance rates have both risen. Equity prices are up over 20 per cent since the middle of last year. And the level of consumer confidence is now well above its long-run average level (Graph 5). Despite what one often hears, households do appear to be feeling better about both their finances as well as Australia’s medium-term prospects.
The one notable exception to the expected responses following a substantial easing of monetary policy is that there has been little movement in the exchange rate. However, this reflects the global factors that I talked about earlier, and the Reserve Bank has attempted to calibrate the setting of monetary policy to take account of this.
Now, if the monetary transmission mechanism works broadly as it has in the past, then an improvement in consumer sentiment and higher asset prices should feed through, in time, to higher spending by households. There are some signs, albeit still tentative, that this is beginning to occur. ABS data and the Bank’s liaison suggest slightly firmer retail spending over recent months than over the second part of last year, though conditions remain mixed across the industry. There are also signs of a pick-up in the forward indicators for new dwelling construction across many areas of the country. In addition, a number of labour market indicators, after having softened last year, have had a slightly firmer tone of late.
Another critical element in the monetary transmission process is a pick-up in private business investment. This is often the last link in the chain, and typically follows increased confidence and higher spending. Given the nature of the investment boom we are currently experiencing, it is non-mining investment where we are looking for this pick-up to occur. As mining investment inevitably peaks and then gradually declines, a critical question for the outlook is the strength of this expected pick-up in non-mining investment.
So, it’s a green light from the RBA to get out there, leverage up some assets and consume. Astute readers will know that there has been one problem with this model of growth since the GFC. That is, it relies heavily upon banks borrowing large sums of international money to pump up the asset prices that underpin the consumption at home. Since the GFC the RBA has made a very deliberate effort to prevent households increasing their borrowings as part of a program to contain the risks arising from external funding. That has now definitively changed.
Last week I noted that Christopher Kent was signaling the RBA’s comfort with a new housing boom. And as well as Phil Lowe’s exhortation to consume this morning, we have another speech today from Guy Debelle, Assistant Governor at the bank, examining the changing dynamics of bank funding. It is long and boring to most of you but in it he says:
In the unsecured market, banks continue to keep their stock of term debt relatively constant, that is, issuance is broadly in line with maturities. This strategy is the result of a number of different considerations, including the relatively subdued growth in balance sheets. But one dominant cause is the desire to maintain a strong rating, with the latent threat of a downgrade if wholesale issuance were to grow ‘too large’. This reflects the somewhat misplaced assessment of ‘deposits good, wholesale funding bad’. As a result, banks are currently paying about the same price for a 3-month term deposit as they are for a 5-year debt issue.
This is either the single most irresponsible statement by the central bank since the GFC, or it is sea-change in their attitude to offshore bank borrowing, or it’s both. If the central bank is happy to see a ramp in wholesale funding then my faith that APRA might stand in the way is also badly shaken.
The RBA’s last three speeches combine to form a singular scream at banks and consumers that it’s party time. Get out there, leverage up some assets and blow it all as soon as you can. Where going to party our way through and over the mining investment cliff. Woohoo!