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Economic Insights

Economics | March 7 2014

RBA Governor promotes interest rate stability Reserve Bank Governor Testimony  The Reserve Bank Governor has delivered testimony to the House of Representatives Economics Committee.  The Governor has delivered his clearest statement yet that the economy is lifting and the focus is now on ensuring that the inflation is contained, households don’t over borrow and, more importantly that growth is manageable.  The clear sense from today’s testimony to the Parliamentary Economics Committee is that Reserve Bank officials are extremely comfortable with current settings. “We have signalled the likelihood, if the economy evolves more or less as expected, of a period of stability in the cash rate. As well as the low level of interest rates generally, a sense of stability should be of some help for businesses and households as they form their plans”.  The tone and comments from the testimony is consistent with CommSec’s view that the cash rate will remain on hold until later in the year before lifting.

What does it all mean? 

The Reserve Bank Governor has delivered his clearest statement yet that the economy is lifting and the focus is now on ensuring that the inflation is contained, households don’t over borrow and, more importantly that growth is manageable. The clear sense from today’s testimony to the Parliamentary Economics Committee is that Reserve Bank officials are extremely comfortable with current settings.

The Reserve Bank Governor’s commentary was similar to the Monetary Policy Statement released a fortnight ago. However his comments today provided more clarity and reinforced our view that interest rates are solidly on hold in the near term and likely to lift by the end of the year. Interestingly the question and answer time was a lot more insightful than the prior testimony in December where it was more dictated by political self-interest than macroeconomic interests.

There was a lot of robust discussion on a variety of issues ranging from the lift in house prices, the likely impact in housing affordability, China’s shadow banking system, the level of foreign investment and rather amusingly a question on what is “jawboning” in the context of the currency.

The forward-looking indicators across the economy are consistent with a lift in activity over coming months. The Governor made mention that while unemployment will continue to lift; it is a lagging indicator “tending to lag by 1-2 quarters”.

Interestingly the Governor discussed the “new normal” that we have noted in previous reports. Stevens indicates that current credit growth of 5-6% “is ok” and that it was unlikely “we will be going back to 15%-16%” credit growth. The Governor mentioned that household debt levels are high but not disastrous and a sedate level of credit growth would be the best outcome for a sustainable longer-term growth story.

The clear sense from today’s testimony to the Parliamentary Economics Committee is that Reserve Bank officials are comfortable with current settings. Interest rate settings are well below a “normal” or neutral setting, but they are about right for the times. It is clear that the Reserve Bank is well aware of the multispeed nature of the domestic economy and the super stimulatory environment was not only insulating the economy from the pullback in mining investment but also underpinning a lower currency – boosting exports.

Savanth Sebastian – Economist (Author) (612) 9118 1805 (work); Twitter: @CommSec Produced by Commonwealth Research based on information available at the time of publishing. We believe that the information in this report is correct and any opinions, conclusions or recommendations are reasonably held or made as at the time of its compilation, but no warranty is made as to accuracy, reliability or completeness. To the extent permitted by law, neither Commonwealth Bank of Australia ABN 48 123 123 124 nor any of its subsidiaries accept liability to any person for loss or damage arising from the use of this report. The report has been prepared without taking account of the objectives, financial situation or needs of any particular individual. For this reason, any individual should, before acting on the information in this report, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice. In the case of certain securities Commonwealth Bank of Australia is or may be the only market maker. This report is approved and distributed in Australia by Commonwealth Securities Limited ABN 60 067 254 399 a wholly owned but not guaranteed subsidiary of Commonwealth Bank of Australia. This report is approved and distributed in the UK by Commonwealth Bank of Australia incorporated in Australia with limited liability. Registered in England No. BR250 and regulated in the UK by the Financial Services Authority (FSA). This report does not purport to be a complete statement or summary. For the purpose of the FSA rules, this report and related services are not intended for private customers and are not available to them. Commonwealth Bank of Australia and its subsidiaries have effected or may effect transactions for their own account in any investments or related investments referred to in this report.


Economic Insights: RBA Governor promotes interest rate stability

Interestingly the Governor made the distinction with a wry smile that “jawboning” may be a fancy term given by market commentators to the Reserve Bank having a subtle view on the currency. In recent times the central bank has made it pretty clear that a lower Aussie dollar would be preferable in an effort to supporting activity. The Governor was pushed on the issue of surprisingly high inflation despite a weak labour market and he suggested that the current inflation landscape is a puzzle and there may be some “noise in the quarterly inflation read.

Overall it is clear the outlook for the economy has improved over the last few months. And while the growth in house prices has been unsettling from an affordability sense, it has lifted wealth levels and also supported confidence. Importantly the lift in dwelling approvals to record highs should ensure that more sedate price growth takes place over the second half of the year.

The impact that foreign residential property investment is having on inflating property prices was discussed and the Reserve Bank Governor mentioned that “in particular parts of our cities, the role of foreign investors is quite prominent indeed, but I suspect rather less prominent than some of the headlines might suggest”. It is likely to be a topic of future discussion and the Central Bank may provide further opinion on this issue.

The Reserve Bank Governor was asked about the role of macro prudential tools (such as mandating borrowers to have higher deposits before seeking home loans) to quell strong growth in house prices. The Governor said that it could be “a useful adjunct” to monetary policy but that we need to “go into this with a bit of realism”. Stevens noted that higher loan to valuation ratios could hurt first home buyers in particular. And this would have deeper ramifications of a political nature.

The Reserve Bank remains quietly confident that the Australian economy is on a sustainable recovery path. House prices are rising, share markets are healthier, population growth is strong, retail activity is lifting and consumer confidence is more upbeat. That doesn’t mean that there are no risks ahead – there always are. But the Reserve Bank Governor believes we are in a happy place.

What does the testimony reveal? Economic outlook 

“forecasts for the global economy haven't changed much in recent months. If anything they have inched higher. They suggest that 2014 growth will be higher than in 2013, and at about average pace. More of the growth is coming from the advanced countries, and proportionately not quite so much from the emerging ones. That, too, is probably a welcome re-balancing in some respects after the weakness of the advanced countries in recent years.” Terms of Trade 

“Australia's terms of trade have been little changed over the past year, though we still assume they will decline further in the future”.

“Export volumes for resources are growing strongly, as the capacity that has been put in place by the high levels of investment comes on line. For example, iron ore shipments have risen by about 85 per cent from their levels of five years ago, to around 1.5 million tonnes per day. They will rise further over the coming year or two” Inflation 

“the recent data show inflation in underlying terms at about 2½ per cent over the course of 2013, and a pace higher than that in the second half of the year. This is a change from the middle of last year, when we were receiving data that were lower than expected”. Consumer demand 

“Consumer demand has had a firmer tone over the summer, after a fairly lengthy period of more subdued outcomes. This is evidence in the retail trade and national accounts data and is confirmed in information from the Bank's liaison.” Monetary Policy Outlook 

“At the present time we judge monetary policy to be doing the things it can reasonably be expected to do in the circumstances we face. We have signalled the likelihood, if the economy evolves more or less as expected, of a period of stability in the cash rate. As well as the low level of interest rates generally, a sense of stability should be of some help for businesses and households as they form their plans”. Key aspects of the Q&A

Potential growth of the Australian economy is “3ish” – that is around 3.0-4.0% per annum

Stevens doesn’t believe that our slightly higher inflation rate compared with other countries has reduced competitiveness

Fall in competitiveness would be associated with weaker exchange rate

Competitiveness more a function of productivity, innovation etc

Annual growth of investor housing credit around 8-9% per annum is about “fast enough”

Total credit growth of 5-6% per annum is OK March 7 2014

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Economic Insights: RBA Governor promotes interest rate stability

Warns investors that house prices can fall as well as rise

Pickup in business investment would be welcomed

Stevens doesn’t express concern about extent of foreign investment in Australian real estate

Role of foreign investment in Sydney housing market “quite prominent indeed”

Stevens expects a pickup in productivity

Stevens emphasises that he sees stability in interest rates – not sure of period

Stable interest rates would be “quite helpful for people”

Stevens on Chinese data: “public commentaries frets too much about…monthly PMIs”

Stevens on Chinese investment in overseas property: reflects higher incomes in China and asset diversification

Question of the day: “What is jawboning?”

To counter declines in some industries, Stevens believes that Governments have role in promoting an environment of macroeconomic stability and fostering an environment of innovation and investment in skills.

What is the importance of the report? 

The Reserve Bank Governor testifies to the House of Representatives Economics Committee twice a year.

Transcript of the Reserve Bank Governor’s opening remarks can be found here: http://www.rba.gov.au/speeches/2014/sp-gov-070314.html

What are the implications for interest rates and investors? 

The Reserve Bank is comfortably on the interest rate sidelines. We believe that a rate cut will only be needed if an unpredicted external shock hurts the global economy. Rather confidence levels are lifting; the housing market is strengthening; and downside risks have diminished. The Reserve Bank would be hopeful that the economy continues to lift in coming months, underpinned by super-low interest rates and momentum provided by home construction and sales.

The main game for the Reserve Bank is the changing of the baton of economic growth drivers from mining to other sectors of the economy. In particular the RBA will be closely assessing the shifts in the labour market landscape and non-mining business investment.

It is important to note that rates are at a super stimulatory level. And while the RBA maintains a cautious approach, rates are likely to lift by year end.

Savanth Sebastian, Economist, CommSec Work: (612) 9118 1805; Twitter: @CommSec

March 7 2014

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March 2014 CommBank Economic Insights