Bill Evans: RBA behind the curve

Via Bill Evans at Westpac:

The minutes of the February Reserve Bank Board meeting do not provide much further information than we have seen from other communication from the Reserve Bank in recent weeks including the Governor’s speech to the National Press Club; the Statement on Monetary Policy; and the Parliamentary testimony.

Key to the policy outlook is the final section of the minutes which notes: “Members reviewed the case for a further reduction in the cash rate at the present meeting. This case rested largely on the only gradual progress towards the Bank’s inflation and unemployment goals.” To date of course the word “gradual” is generous given that over the last year the trimmed mean inflation rate has remained around 1.6%yr with the unemployment rate stuck above 5%. We understand that the Bank’s inflation and unemployment goals are for trimmed mean inflation around 2.5%yr and the unemployment rate (current estimate of full employment) at 4.5%.

The minutes point out that policy was eased significantly last year with the cash rate coming down from 1.50% to 0.75% and emphasised that there are “long and variable lags in the transmission of monetary policy”. However the Bank’s own forecasts which were released with the Statement on Monetary Policy on February 7 indicate that the unemployment rate will only fall to 4.8% by June 2022 and the trimmed mean inflation rate will only reach 2% by that time.

Consequently the Bank is accepting that under the current policy settings (and these forecasts assume another cash rate cut which is priced into the market) it will not achieve its inflation and unemployment goals by mid-2022. It may be implying that a gradual move towards these goals is ‘good enough’ but does highlight the risks of any set-backs in this process for policy. In that regard lead indicators around job vacancies and job ads are not encouraging.

The question arises therefore as to why the Board decided not to take further policy action. After all, these minutes and other communications emphasise that monetary policy remains effective, working through the exchange rate; household cash flow; and housing market channels.

The answer to that question lies in the concept of “risks associated with very low interest rates”. The Board refers to the impact of very low interest rates on resources allocation and on the confidence of people in the community, notably those reliant on savings to finance their consumption. Furthermore, and arguably of most importance, is the concern that low interest rates could encourage additional borrowing at a time when there was already a strong upswing in the housing market.

The Board will be aware that housing credit growth is currently at its lowest level (3.1%yr) in the history of the housing credit series. Reasonable assumptions about a strong pick up in new lending for housing are still only consistent with a lift in housing credit growth from around 3%yr to 4%yr in 2020. Consequently the “additional borrowing” argument seems unconvincing.

On the other hand the real issue is likely to be around the unexpectedly rapid increase in house prices across the nation. With house prices already near or above previous highs in some areas (Melbourne; Brisbane; and Adelaide are either above or just slightly below previous peaks) affordability constraints may start to slow the pace of increase unless demand from investors, who have been remarkably restrained in this cycle, starts to gather momentum.

If that is the case then the Board risks the classic challenge of having too many targets and only one instrument. It may be that in time it will recognise the difficulty of that situation and re-target monetary policy at its core objectives of employment and inflation. As we saw in 2015 and 2017 when concerns arose with frothy housing markets, largely driven by investor activity, the authorities successfully addressed that issue with macro prudential policies.

On the international front the minutes noted the coronavirus outbreak as a “new source of uncertainty” and members observed that it was “too early to determine the extent to which growth in China would be affected or the nature of international spill overs”. With the Board noting the expected short term nature of the shock it is likely that a Board that is emphasising the “long and variable lags” of monetary policy would be reluctant to respond to the virus effects with an ‘insurance cut’.

Finally it is important to note that there was a general discussion at the meeting around “the operation of macroeconomic policy and monetary policy frameworks in an environment where interest rates are low because of structural factors”. Issues for discussion were cases for and against aggressive easing when rates are near the lower bound; inflation targets; and fiscal policy.

Conclusion

The meeting discussed a further reduction in interest rates because prospects are for only gradual progress towards the Bank’s inflation and unemployment goals.

The decision to defer hinged largely around the benefits vs the risks of lower rates.

Those risks were around encouraging additional borrowing in the housing market. With housing credit growth benign and little evidence of loose lending practices it seems reasonable that any evidence that the gradual convergence towards the inflation and employment targets is not being achieved will result in further policy easing.

That profile remains Westpac’s view although we recognise that this evidence may take more time to emerge than implied by our current forecast that the next cut in rates will be at the April Board meeting.

Phil from Marketing will have no choice.

David Llewellyn-Smith
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Comments

  1. Jumping jack flash

    “…This case rested largely on the only gradual progress towards the Bank’s inflation and unemployment goals.”

    Gradual for sure. It’ll take about 30 years to return to “normal” after the debt stops being doled out (and along with this the pain of deleveraging and more than likely a debt depression). Or, alternatively, they can dream up some completely fantastic monetary and fiscal policy to accelerate the debt expansion to the rates of expansion that gave us those heady days pre-GFC.

    Oh, the choices that must be made! Decisions, decisions. Still, these are the reasons why our immensely intelligent leaders get paid a small fortune… Or, a large one.

    • Quite right. Political and economic policy appears to be based on the thought that ‘We have driven into a cul de sac and can see the dead-end ahead. Best we keep going. There might be a side street we can duck into before we hit the wall…!”
      The irony is that there is now no other option. We are too far down the track to back out now…

  2. The British knack for understatement was perhaps one large part of their success in diplomacy and maintaining a large empire under bureaucratic control for so long.

    This translates today roughly as ‘Don’t scare the horses’; why we still hang on every word the RBA deploys in this British managerial tradition, in the desperate hope that one day they may actually ‘say something’ is beyond me. These guys will be the last to acknowledge any serious economic change publicly. They are always behind the curve by nature and culture.

    Bill just points out what they are not saying. This is effectively what Bill ‘IS’ saying. Let’s just have Bill, okay? Replace these guys with a homeless man blowing a vuvuzella into a mic every few months or so. And AFTER the economy turns down he presses the ‘cut’ button or AFTER it turns up he presses the ‘raise‘ button. If he is really drunk he just passes out – ‘hold’.

  3. Hilarious!

    A bank economist reckons the RBA should cut interest rates further because demand for his employers product “DEBT” is sagging even with interest rates at records lows.

    You could not get clearer evidence that running a monetary system on private bank credit creation is fundamentally broken but still MOAR of the same is demanded.

    Absurdist theatre at its finest.

  4. When people wake up, they will realise that by the end of this year there will be no buyers of US debt except for the Federal Reserve.
    Bernanke told the US Senate that the Fed would not monetise the debt: they did and they will keep doing it.
    Governments around the world no longer have the means or the intent to repay the bond holders:force majeure.
    Gold was A$77,000 per kg this morning.

  5. Bill spends a lot of time navel gazing. And more often than not gets it wrong, Still, everyone loves him.

  6. Yep, lower teh rates and let’s get this housing party started again!

    No bubbles here – just real wealth.

    • Interesting you say ‘real wealth’. I follow Ben Carlson’s blog and he recently posted this beauty. Plenty of parallels here.
      https://awealthofcommonsense.com/2020/02/the-biggest-problem-in-finance/

      Wealth inequality in America seems to get worse by the year. There too many causes for this to name but one of the biggest problems I see is the fact that the wealthy own such a large proportion of financial assets while the middle class mainly owns their home as their biggest (sometimes only) investment.

      • Yes, my reference to wealth was laced in sarcasm, primarily because monetary policy (perpetually lowering rates) simply boosts asset prices. This is not ‘real’ wealth, it is more ‘optical’ wealth. Boosting the quantity of money (credit) doesn’t create real wealth it simple re-distributes it from the people who hold /earn cash to the people who own assets. Even the dweebs at the Federal Reserve are finally acknowledging this – but still insist that QE has been a raging success.

        Real wealth is accumulated through hard work / innovation / entrepreneurial endeavour and ultimately saving.

  7. In the early years of the passenger car era, it was a commonly taught technique to engage the throttle when there was incipient danger. It was good advice as the braking systems were pretty poor.
    The analogy to Straya’s enormous and growing retail debt position amongst her citizenry could not be more fitting. We have no ‘brakes’ when it comes to debt issuance as the economic edifice is built upon the requirement to keep inflating house prices or the engine will seize. Of course rates will drop and more will borrow; there can be no other way now as it’s all we’ve got and everybody knows it.

    This approach may have some time yet to run and the enthusiasm for ‘our’ model may continue to thrill the participants but all that debt represents a very real and invisible brick wall in the future and all this ‘throttle’ applied now will have its expected consequence.

    • There seems to be a big division between Sydney/Melbourne/Canberra and the rest of the country. I hardly speak to anyone in business who is not severely stressed. Western Suburbs Brisbane I went down to the local hire place. I seemed a bit quiet. On enquiry the bloke responded – Yes! 2019 was bad on the whole now it’s just terrible. Normally 3 trucks out delivering and picking up gear – now less than one.
      I reckon a hire business might not be a bad barometer.
      Anyway, lower the rates! Insanity rules and being sane in the midst of the madness is about the worst existence one can have.

  8. happy valleyMEMBER

    Good on ya Bill – ready to put the knife in to savers and fixed interest income reliant retirees again. You’re a class act.