March GDP Result Weak Again

Australia’s gross domestic product (GDP) grew by 0.4% in the March quarter 2019, following a 0.2% rise in the December quarter. The Australian economy grew 1.8% through the year, according to the ABS. This is well below the 2.75% trend average. The expenditure measure of GDP grew by only 0.2%, below expectations.

Trend GDP per capita was negative for the second quarter in a row.

Housing and the consumer spending eased as a result of a further tightening of lending standards and persistent weak wages growth. Plus the drought in NSW and surrounds added to the downside drivers.

Government final consumption expenditure rose 0.8% in the quarter and remains strong through the year at 5.1%. National non-defence (2.4%) was the main contributor to growth, due to increases in social benefits to households from continued government spending on disability and health services. State and local government expenditure increased 0.4% driven by rises in employee expenses.

Dwelling investment fell 2.5% in the quarter, falling 3.1% through the year. This fall follows significant falls in dwelling approvals. Prior to this, dwelling investment reached record levels in September quarter 2018.

Non-mining investment grew 2.0%, driven by broad based investment in new buildings, particularly offices and accommodation buildings. Mining investment continued to decline, falling 1.8% in the quarter.

Household final consumption expenditure increased 0.3%, with through the year growth moderating to 1.8%. Households reduced discretionary spending, in particular on recreation and culture, hospitality and furnishings and household equipment.

The household saving ratio rose to 2.8 with growth in household disposable income outpacing subdued growth in household spending. The growth in gross disposable income was primarily driven by continued growth in compensation of employees. Non-life insurance claims continued to contribute to household income following a significant rise in the December quarter. These insurance claims are related to recent natural disaster events, namely the Sydney hail storms in December quarter and Queensland floods in the March quarter.

Visionary RBNZ Shows Up RBA

The Reserve Bank of New Zealand has released an important statement on the new approach they are going to adopt in policy setting. The focus will be on improving wellbeing. In addition they are expanding their dna to avoid group think. This follows their recent moves to lift bank capital.

There is so much here the RBA should embrace.

The Reserve Bank has significantly changed the way it makes monetary policy decisions, keeping itself in step with public expectations.

In a panel discussion last week at the Institute for Monetary and Economic Studies (Bank of Japan) in Tokyo, Reserve Bank Assistant Governor and General Manager of Economics, Financial Markets and Banking Christian Hawkesby talked about the importance of good decision making and governance, and of being credible and trusted, in achieving the long-term goal of improving wellbeing.

“We maintain our legitimacy as an institution by serving the public interest and fulfilling our social obligations. Keeping our ‘social licence’ to operate depends on maintaining the public’s trust that we are improving wellbeing,” Mr Hawkesby said.

“Thirty years ago New Zealand was prepared to accept a single expert – the Governor – making decisions about how to fight inflation. People now expect to see how and why decisions are made, expect that decision makers reflect wider society, and that current issues and concerns are factored into the decision making. By meeting these expectations, we can improve public trust in the legitimacy of the Reserve Bank’s work,” he said.

Mr Hawkesby outlined the new committee process that the Reserve Bank uses for deciding the official cash rate, noting that diversity among decision makers improves the pool of knowledge, insures against extreme views, and reduces groupthink.

“This diversity is needed to confront issues such as climate, technological, and other structural and social changes,” he said.

He also said that collaboration with government can be undertaken in a way that maintains the Reserve Bank’s political independence while working on the broader objective of improving wellbeing.

Here is the supporting speech.

Introduction

Tena koutou katoa

Thank you for the opportunity to talk about the Reserve Bank of New Zealand and the changes we are making to maintain our credibility in times of change.

I would like to focus on two building blocks of credibility:

  • renewing a social licence to operate by aligning our objectives with the needs of the public; and
  • achieving those objectives through good decision making enabled by a framework of good governance.

A common theme is the importance of transparency.

The imperative for change: Central banks in the 21st century

The first building block of credibility is the renewal of a social licence to operate—by this I mean the legitimacy an institution earns by serving the public interest. It is granted by the public when an institution is seen to fulfil its social obligations.1

New Zealand was the first country to officially adopt inflation targeting in 1989, with a number of central banks around the world following the example.2 Under a single-decision-maker model, we brought inflation down from around twenty percent to two percent in five years. In doing so, we helped build our credibility during the high-inflation environment of the times.3

Fast-forward to 2019, and monetary policy in New Zealand has undergone major change. Firstly, we have adopted a dual mandate, focused on achieving price stability and supporting maximum sustainable employment. Secondly, we have adopted a committee structure for decision making, and are delivering greater transparency in our decision making.

Why the change?

The reform of our framework was not merely a simple choice based on technical performance. As you can see in figure 1, when it comes to inflation and growth, over the past 30 years inflation-targeting central banks (e.g. New Zealand and the United Kingdom) have a pretty similar track record to central banks with a dual mandate (e.g. Australia and the United States). 4

The imperative for change comes from more than examining our history; it comes from our expectations of the future, and the present we find ourselves in. Our policy framework changed because times are changing. For the Reserve Bank to maintain its credibility and relevance, we must change too.

Figure 1: Inflation, and GDP growth across monetary policy frameworks5

figure-1

Wellbeing of our people

Inflation has been low and stable in New Zealand for nearly 30 years.

There is a greater appreciation that low inflation is a means to an end, and not the end itself. In the fight to lower inflation that was perhaps easy to forget. The end goal is, of course, improving the wellbeing of our people.6

For many in the general public, employment is one tangible measure of wellbeing. Employment can provide an opportunity to earn your own wage, contribute to society, and live a fulfilling life.

It is in this light that the Reserve Bank Act (1989) has been amended to include a dual mandate with an employment objective alongside our price stability goal. Incorporating the objective of supporting maximum sustainable employment, and equally weighting it alongside inflation, emphasises our long-term goal of improving New Zealanders’ wellbeing. This aligns us with the needs of the public. And it helps us renew our social licence to operate – the first building block for maintaining our credibility.

But it is not enough for the public to believe in and understand our objectives. We must also prove to them that they can be achieved. This brings us to the second building block necessary for maintaining credibility: establishing modern governance principles for dealing with modern problems, and translating good governance into good decisions.

Good governance

In preparing for our dual mandate, and a formal Monetary Policy Committee (MPC), we have updated the principles and processes that form our governance framework for monetary policy.

In pursuit of greater transparency, we have also published these principles and processes in a comprehensive Monetary Policy Handbook (the Handbook). 7 This is an essential document, for everyone from school students to MPC members.

Importantly, it is also a living document that will evolve as our understanding evolves.

Principles

The first part of the Handbook I would like to cover is the section on MPC deliberation principles. 8

Figure 2: MPC deliberation principles

There are three principles which guide the deliberations within the MPC.

I’ve talked already about providing clarity around our objectives – the equal weighting of our employment and inflation goals. This is the first of our three principles.

The second, is diversity – diversity in the skills, experiences, thoughts, and personal characteristics of the MPC members.

The third, is inclusion – inclusion of information and people, ensuring decisions are made on the basis of all the available insights, and reflecting the views of all of the committee members.

Why are diversity and inclusion so important?

The governance literature shows that diversity and inclusion improves the pool of committee knowledge, insures against extreme views, and reduces groupthink.9 These principles drive the committee towards an unbiased policy decision – the best that is possible given existing information.

Think about this from a practical perspective. Modern monetary policy is confronted by diverse issues such as climate, technological, and other structural and social changes. A sole decision maker or uniform committee cannot possibly hope to possess the broad range of insights necessary to consider these issues.

A diverse committee operating in an inclusive environment can. It is these additional insights that improve collective understanding, and lead to better monetary policy decisions.

So you see these principles are not simply rhetorical devices. They are carefully chosen pillars to support our credibility though good decision making in achieving our dual mandate.

Good decision making

Processes

Our principles of good governance have directly influenced the policy-setting process of the MPC. 10 This is a process that has been designed with consensus-based decision making front and centre, consistent with the agreement with the Minister of Finance. 11

Figure 3: The structure of the forecast week for quarterly Monetary Policy Statements

We begin with information pooling, which flows through to MPC deliberations, and culminates in the final decision making meeting.

As you can see, the policy-setting framework is highly collaborative and deliberate. Deliberate in the sense that the process inspires lively debate, giving MPC members every possible chance to challenge assumptions, critique policy judgements and assess a range of policy strategies to achieve our dual mandate objectives.

A crucial part of this is that the MPC members hold back their views on the decision until the final stages, rather than starting with them. This supports evidence-based decision making and guards against confirmation bias.

The process begins with open information pooling on recent developments and the outlook for the economy. Here, the MPC have the opportunity to investigate and challenge the assumptions made in the staff’s initial forecasts. This is where the MPC member’s judgement enters the picture, and where creative tensions improve collective understanding.

While the MPC members may enter the room with different insights and questions about the economy, at the end of the information pooling stage the committee shares a common reference point for the economic outlook.

There are numerous opportunities to discuss and reflect on key issues, judgements, risks, strategy, and communication throughout the week. There are also a number of anonymous internal surveys we perform to gauge collective opinion among staff and MPC members.12

By the end of the week-and-a-half, the final monetary policy decision reflects the greater momentum of the MPC’s discussion.

We publish the final Official Cash Rate (OCR) decision, a Monetary Policy Statement (MPS), and a Summary Record of Meeting at the same time.

The Summary Record of Meeting captures the key judgements and risks underpinning the central forecasts and decision, as well as indicating where members of the MPC had different views. We identify any differing views, and communicate where the most significant uncertainties lie in our baseline forecasts.13 If consensus cannot be reached, a vote by simple majority would be carried out, and the reasoning behind different stances disclosed in the Summary Record of Meeting.

Our desire is that the transparency provided in the Handbook can help the public understand how the Bank’s collective ‘mind’ works. If the public can see the analytical rigour in our decision making, they should have greater confidence in the MPC’s conclusions, and thus more faith in the Reserve Bank.

Our credibility will be supported in the long run if the decisions made by the MPC are unbiased and effective ones. Our results will speak louder than our words.

Monetary policy strategy and our May decision

So far I’ve talked about the principles and processes we follow in setting policy. Now I’m going to cover how we ‘walk the talk’ in formulating our monetary policy decisions.14

Sound and effective monetary policy strategy requires more than just deciding whether the OCR should go up or down on any given day; instead central banks need to be transparent about their views of the economy over the medium-term and how monetary policy might respond to a changing economic landscape.

In this regard, around twenty years ago, the Reserve Bank became a pioneer in another way. When publishing our interest rate decisions, we also began to publish a forward (and endogenous) projection of interest rates in the future. We use this to capture the overall stance of monetary policy.

This tool remains integral to how the MPC sets monetary policy and understands the potential trade-offs with a dual mandate.

The first monetary policy decision of the new MPC occurred last month, in May. Our starting point was a New Zealand economy where the labour market was operating near maximum sustainable employment, and annual core inflation pressures were within our 1 to 3 percent target range but below the 2 percent mid-point.

We discussed the slowdown in global growth, and how this might affect New Zealand. We also addressed the recent loss of domestic economy momentum since mid-2018, through both tempered household spending and restrained business investment.

In order to continue achieving our policy objectives, we agreed that additional monetary stimulus was needed to help bring inflation back to the 2 percent mid-point and support maximum sustainable employment. We then turned to the question of the magnitude of stimulus we wanted to adopt (the stance) and the timing and means by which we would try to deliver this (the tactics).

Figures 4–6 show how different OCR paths could have been used to achieve our objectives. While each path was consistent with meeting our objectives, they each offered different trade-offs.15

Figure 4: Official Cash Rate (OCR) paths to achieve alternative monetary policy stances

figure-3

Figures 5-6: Inflation, and employment gap under alternative OCR paths

figure-4

If we kept rates unchanged (the higher OCR path), our projections suggested that it would have taken a number of years for inflation to return to target, and employment would have fallen below the maximum sustainable level. If we lowered the OCR by around 75 basis points over the next 12 months (the lower OCR path), our projections suggested it would result is a situation where both inflation and employment would be overshooting their targets.

By contrast, the baseline (our final published projection), with the OCR around 40 basis points lower over the next 12 months, brought inflation back to target in a reasonable time period, with employment remaining near the maximum sustainable level. We decided this path captured our preferred strategy, and was robust to the key risks we had discussed.

After agreeing on the appropriate stance of monetary policy, MPC turned to the tactical decision of where to set the OCR at the May meeting, and decided to cut the OCR by 25 basis points to provide a more balanced outlook for interest rates.

This brings us to discuss the future.

Maintaining credibility in the future

Our central view is that New Zealand’s interest rates will remain broadly around current levels for the foreseeable future. However, we need to be ready to adapt to changing conditions, to meet our objectives even when confronted with unforeseen developments.

An issue that policymakers and academics are grappling with around the world is the role of both monetary and fiscal stimulus in a world of low interest rates.

There is emerging consensus that coordination is necessary for an optimal response of broader macroeconomic policy.16 For central banks, operational independence does not have to mean operational isolation. Rather, collaboration with government can be done in a way that builds and reinforces the social licence to operate, by showing a willingness to work with other partners to do whatever is necessary to achieve the broader objective—improving public wellbeing.

Even with coordination between monetary and fiscal policy, if further macroeconomic stimulus is needed quickly, the first line of defence will still inevitably fall upon central banks.17

In New Zealand, we are in the strong position of having further room to provide conventional monetary stimulus if required (using the OCR).

Having effective unconventional policy options expands the toolbox of a central bank, which is naturally more relevant in a low interest rate environment. In this spirit, we published a Bulletin article last year on the practicalities of unconventional monetary tools in a New Zealand context, and we continue to learn from the lessons of our central banking cousins.18

It’s better to have a tool and not need it, than need one and not have it.

Conclusion

In the Handbook, we explore the history of central banking objectives, and see how dramatically they have evolved over time. 19 We haven’t always had a mandate to support maximum sustainable employment, or to achieve price stability, or even control over interest rates or the money supply.

Nothing lasts forever, and it is possible that the role of central banks may change again in the future. Our Handbook will inevitably change. We need to be ready to adapt when changes beckon.

And it is not enough to grudgingly adapt. In order to maintain credibility, central banks must embrace change and prove to the public that they are capable of delivering on their objectives. To remain credible is to remain relevant. Central banks should keep their eyes open, and be ready to change tack. Our destination—a world with improved wellbeing for our citizens—may not change, but the best route for getting there may.

We must adapt. We must continue to improve the wellbeing of our citizens. We must remain credible.

Meitaki.

Thank you.

Mortgage Stress Higher Post the Election

Digital Finance Analytics (DFA) has released the May 2019 mortgage stress and default analysis update.  Perhaps the rate cuts, rise to the minimum wage, and tax cuts ahead may turn the tide, but so far none of this matters for current household budgets. On the other hand more lending may make budgets even tighter if standards are dropped further.

Once again, it’s the continuing story of pressure on households as ongoing wages growth is not offsetting costs of living, and mortgage repayments as total debt continues to rise. Moreover, the trends have continued post the election.

Across Australia, more than 1,071,829 households are estimated to be now in mortgage stress (last month 1,050,450), another new record. This equates to more than 31.9% of owner-occupied borrowing households. In addition, more than 33,427 (30,413 last month) of these are in severe stress. We estimate that more than 70,502 (last month 70,149) households’ risk 30-day default in the next 12 month. This is as the impact of flat wages growth, rising living costs and higher real mortgage rates hit home.  Bank losses are likely to rise a little ahead.

Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to the end of May 2019. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.

Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. They may or may not have access to other available assets, and some have paid ahead, but households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home.  Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.

Martin North, Principal of Digital Finance Analytics says that now the election results are known, and the dust has settled, we are still seeing the pressures on households are rising, thanks to an accumulation of larger mortgages compared to income whilst costs are rising, and incomes remain static.  Housing credit growth is still running significantly faster than incomes and inflation and continued rises in living costs – notably child care, healthcare costs, school fees and electricity prices are causing significant pain. Many households are depleting their savings to support their finances or are trying to refinance.   

Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes.  Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households, contrary to the popular belief that affluent households are well protected.  This is shown in the segment analysis below:

Stress by the numbers.

Regional analysis shows that NSW has 297,995 households in stress (284,014 last month), VIC 290,581 (292,114 last month), QLD 193,155 (184,037 last month) and WA has 140,950 (140,836) last month). The probability of default over the next 12 months rose, with around 13,222 (13,135 last month) in WA, around 12,948 (12,936 last month) in QLD, 17,773 (17,611 last week) in VIC and 18,822 (18,703 last month) in NSW.  

The largest financial losses relating to bank write-offs reside in NSW ($1.1 billion) from Owner Occupied borrowers) and VIC ($1.54 billion), though losses are likely to be highest in WA at 3.1 basis points, which equates to $1,107 million. 

A fuller regional breakdown is set out below.

Here are the top postcodes sorted by number of households in mortgage stress.

Handling Mortgage Stress

Households who are in financial difficulty should not ignore the signs. Though many do. And trying to refinance to solve the problem often ends up just postponing the inevitable. 

We think there are some simple steps households can take:

Step one is to draw up a budget, so you can see where the money is coming and going. From our research, only half of households have any budget. This means you can then make decisions about what is most important, and what can be foregone. Select and prioritise.

Step two is to talk with your lender, as they have a legal obligation to assist is case of hardship. Yet many households avoid having that conversation, hoping the problem will cure itself. I have to say, in the current low-income growth, high cost environment, that is unlikely.  And remember rates are likely to rise at some point.

Step three. Work out what would happen if mortgage rates rose by say half or one percent. Pass that across your budget and examine the impact. Then you will really know where you stand. Then plan accordingly.

You can request our media release. Note this will NOT automatically send you our research updates, for that register here.

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Note that the detailed results from our surveys and analysis are made available to our paying clients.

The Banks Respond To The Cash Rate Cut

The big four all announced cuts in their variable mortgage rate (around 75% of borrowers are on variable rates), but the amount of the cuts and the timing does vary between banks.

Both the RBA Governor and The Treasurer on the record said the banks should pass through the full cuts. Borrowers should shop around and demand a better rate – which is always good advice!

The funding position of the banks, as represented by the BBSW is also supportive of a pass though.

Analysts were expecting about half to pass through, which would be neutral to profits, thus, those who pass through more will see their margins compressed, and it is certain they will cut deposits rates to alleviate this. Funny how deposit rate cuts are hardly reported, and never make the headlines.

As a rule of thumb, a 5 basis point net margin reduction translates into a 1% fall in profit.

One problem is that many call deposits are close to zero now, so expect a bigger trimming of term deposit rates. We also expect some savers to pull funds from deposits to try other investments with a higher return, though with higher risks.

This is how the majors came out:

ANZ

Their Australian variable mortgage rates to decrease by 18 basis points, which is 7 basis points lower than the RBA 25 basis point cash rate cut. This will be effective from the 14th June.

CBA

Their Australian variable rate home loans will decrease by 25 basis points. This will be effective from 25th June. Given their better systems this is a deliberate delay in my view, to protect profits.

NAB

Their Australian variable rate home loans will decrease by 25 basis points. This will be effective from the 14th June.

Westpac

Their Australian variable mortgage rate will decrease by 20 basis point, though its Investor interest-only home loans will reduce by 35 basis points. This will be effective from the 18th June.

Generally investment mortgages now carry a higher mortgage rates than owner occupied lending of course.

Regionals and smaller players already have margin pressures and competitive disadvantage to cope with, yet they will have to keep their rates in line with the market to maintain new and existing business flows.

We are entering a diabolical phase in our interest rate history, and this signals ongoing economic weakness.

The RBA Will Cut Again, And AGAIN

From The Conversation: The Reserve Bank cut interest rates on Tuesday because we aren’t spending or pushing up prices at anything like the rate it would like. And things are even worse than it might have realised.

As the board met in Martin Place in Sydney, in Canberra at 11.30 am the Bureau of Statistics released details of retail spending in April, one month beyond the March quarter figures the bank was using to make its decision.

They show the dollars spent in shops fell in April, slipping 0.1%, notwithstanding weakly growing prices and a more strongly growing population.

The March quarter figures the board was looking at were adjusted for prices. They show that the volume of goods and services bought, but not the amount paid for them, fell in seasonally adjusted terms during the March quarter.

Adjusted for population, the volume bought would have fallen further.

We’ll know more on Wednesday

The Bureau of Statistics will release population-adjusted figures as part of the national accounts on Wednesday.

The figures for the September quarter show that income and spending per person barely grew. The figures for the December quarter show income and spending per person fell.

A second fall in the March quarter will mean two in a row – what some people call a per capita recession.


Australian National Accounts

Even unadjusted for population, economic growth is dismal.

During the September and December quarters the economy grew just 0.3% and 0.2% – an annualised rate of just 1%.

That’s well short of the 2.75% the treasury believes we are capable of, and the lower than normal 2.25% it has forecast for the year to June.


Australian National Accounts

We’ve been doing it by ourselves. As Reserve Bank Governor Philip Lowe said in announcing the rates decision on Tuesday:

The main domestic uncertainty continues to be the outlook for household consumption, which is being affected by a protracted period of low income growth and declining housing prices.

The bank wants both inflation and employment higher, and it wants us to spend more in order to do it. Lower rates should help, although not for everybody.

Lowe acknowledged this is a speech to a Sydney business audience on Tuesday night, but he said households paid two dollars in interest for every one dollar of interest they received. So while rate cuts hurt savers, they benefit borrowers by more, and over time should benefit all households by boosting the economy. They also drive the dollar lower, making Australian businesses more competitive.

Tuesday’s cut should free up an extra A$60 a month for a typical mortgage holder. Another one will free up a total of $120.

It’s not much, and there’s doubt about whether it will do much, but interest rates are about the only tool the Reserve Bank has.

It is required by its agreement with the government to aim for an inflation rate of between 2% and 3%, “on average, over time”.

Treasurer and Reserve Bank Governor, Statement on the Conduct of Monetary Policy, September 19, 2016. Reserve Bank of Australia

Uncomfortably for Governor Lowe, underlying inflation (abstracting from unusual moves which are quickly reversed) has been below 2% ever since he was appointed governor in late 2016.

Explaining his push for higher inflation to a business audience in Sydney on Tuesday night he said that while adherence to the target was intended to be flexible, that flexibility was “not boundless”.

If inflation stays too low for too long, it is possible that inflation expectations move lower – that Australians come to expect sub-2% inflation on an ongoing basis. If this were to happen, it would be harder to achieve the medium term inflation goal. So we need to guard against this possibility.

He is also required to aim for full employment.

He told the business audience that while for some years the bank and others had thought full employment meant an unemployment rate of 5%, the absence of inflation at 5% and the persistence of underemployment (where people wanted more hours) meant it could and should go lower.

Our judgement now is that we can do better than this – that we can sustain an unemployment rate of 4 point something.

Lower interest rates should help by making it easier to businesses to borrow to expand, and giving consumers something in their pockets to buy from them.

If you don’t succeed…

If that doesn’t happen, the bank will cut again.

Tuesday’s statement as good as said so:

The board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time.

Tuesday’s cut and the next will take the bank into uncharted waters, where its so-called cash rate – what it pays to banks to deposit money with it overnight – is close to zero.

As far as can be discerned it has never been that low in the 100+ years the Reserve Bank has been in operation, originally as the Commonwealth Bank of Australia.


Reserve Bank cash rate since 1990

Reserve Bank of Australia

Should inflation still not pick up and employment still not fall as far as it believes it could, it will have to effectively cut its cash rate below zero, forcing cash into the hands of banks by aggressively buying government bonds, giving them little choice but to lend it to households and businesses, in a process known as quantitative easing. It has been done in the United States, Europe, the United Kingdom and Japan, and is by now anything but unconventional.

Governor Lowe would prefer the government to pull its weight by cutting tax and boosting spending, especially on infrastructure, and by policies that make Australia more productive.

He said so on Tuesday night

the best approach to delivering lower unemployment and a stronger economy is through structural policies that support firms expanding, investing, innovating and employing people. As we ease monetary policy, it is in the country’s interest that other policy options are considered too.

Treasurer Josh Frydenberg gets it.

He pointed out on Tuesday that the yet-to-be-approved tax offsets in the budget will give Australians on up to $126,000 a cash bonus of up to $1,080 when they submit this year’s tax return, far more than the rate cut.

His biggest concern, and the biggest concern of the governor, might be that they don’t spend it. Another concern would be that the banks don’t pass the rate cut on.

The ANZ has said it will only cut mortgage rates by 0.18 points instead of the full 0.25, a decision Frydenberg said “let down” customers. Westpac has cut by only 0.20 points. The National Australia and Commonwealth banks have passed on the cut in full.

On Tuesday night in Sydney Governor Lowe addressed the question of whether the banks should have passed on the full cut head on:

My usual practice in answering this question has been to explain that there are a range of other factors that influence mortgage pricing, and then say “it all depends”.

Today, though, I would like to break with my usual practice and provide a clearer answer. And that is: Yes. There has been a substantial reduction in the cost of banks raising funds in wholesale markets. Average rates on retail deposits have also come down.

This means that the lower cash rate should be fully passed through into standard variable mortgage rates. Full pass-through would also mean that the economy receives the full benefit of today’s policy decision.

The Governor is concerned that, for their own reasons, lenders such as ANZ and Westpac are forcing him to cut rates lower than he should and making an already difficult job harder.

If he has to cut further he will, but with the cash rate at just 1.25%, he would dearly love not to have to.

Author: Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

The RBA On The Cash Rate Cut

Governor Lowe explains. In summary: Expect more cuts. Banks should pass on the cuts. Borrowers will benefit more than savers in the interests of the economy. The exchange rate will fall. Spare capacity in the economy needs to be utilised.

At its core, today’s decision was taken to support employment growth and to provide greater confidence that inflation will be consistent with the medium-term target.

I want to emphasise that the decision is not in response to a deterioration in our economic outlook since the previous update was published in early May. The economic outlook remains reasonable, with the main downside risk being the international trade disputes, which have intensified recently. The Australian economy is still expected to strengthen later this year, supported by the low level of interest rates, a pick-up in growth in household disposable income, ongoing investment in infrastructure and a brighter outlook for the resources sector. So today’s decision does not reflect a weaker outlook. Rather it reflects the fact that, even with the expected pick-up in growth, the Australian economy is likely to have spare capacity for a while yet.

Today’s easing of monetary policy will help us make further inroads into that spare capacity. It will assist with faster progress on reducing unemployment and will help achieve more assured progress towards the inflation target. So that is our rationale.

I know that many of you are likely to have questions about today’s decision. I would like to take this opportunity to provide answers to some of your probable questions. I am also happy to answer your other questions after my prepared remarks.

The four questions that I thought it would be useful to answer are the following:

  1. Why did the Board act today, after having held the cash rate steady for more than 2½ years?
  2. Are there more interest rate reductions to come?
  3. Should today’s reduction be fully passed through to mortgage rates? and
  4. What about the savers – has the Board forgotten about them?

First, why move now, after holding steady for so long?

The answer is the accumulation of evidence. As you would expect, the Board is constantly sifting through masses of data and seeking to understand what are often conflicting signals about the economy. As we have gone about this task over recent times, there has been a progressive accumulation of evidence in support of two conclusions.

The first is that inflation pressures are subdued and they are likely to remain so.

And the second and related conclusion is that there is still significant spare capacity in the Australian labour market.

The most recent batch of data has provided further evidence in support of both conclusions. The March quarter CPI was low and it was below expectations, as was the previous reading on inflation. In addition, the wage data for the March quarter confirmed that wages growth remains subdued, although it has picked up from a year ago. And the recent labour market report also confirmed that strong employment growth is not making material inroads into spare capacity in the labour market. The Board judged that the accumulation of this further evidence meant that it was now appropriate to adjust monetary policy.

Given the importance of these two conclusions, I would like to elaborate a little on them and explore their implications.

The subdued inflation pressures reflect a number of factors. These include slow growth in wages, increased competition in retailing, the adjustment in the housing market – with rents increasing at the slowest pace in decades – and various government initiatives to reduce the cost of living pressures on households. These factors are all putting downward pressure on prices and they are likely to remain with us for some time yet.

Collectively, these factors have contributed to delayed progress in returning inflation to the 2–3 per cent target range. In underlying terms, inflation has now been below 2 per cent for three years and the latest reading was 1½ per cent. Looking forward, inflation is still expected to increase, but it is unlikely to be comfortably within the 2–3 per cent range for some time yet. So the progress on returning inflation to target is more gradual than we had hoped.

It is important to remember, though, that our inflation target is intentionally flexible and that the Australian economy has benefited from this flexibility over the past 25 years. The Board is aiming to ensure that Australia has an average inflation rate of between 2 and 3 per cent over time. The focus is on the average and the medium term.

We have never sought to have inflation always between 2 and 3 per cent. The RBA adopted flexible inflation targeting before other central banks, and this flexibility has served us well. It has allowed the Board to set monetary policy so as best to achieve its broad objectives, with the ultimate aim of contributing to the economic prosperity and welfare of the people of Australia. It has also allowed the Board to look through temporary factors affecting inflation.

This flexibility, however, is not boundless. The point of our inflation target is to provide a strong medium-term anchor that helps deliver low and stable inflation, which, in turn, is an important precondition to sustainable growth in employment and incomes. If inflation stays too low for too long, it is possible that inflation expectations move lower – that Australians come to expect sub-2 per cent inflation on an ongoing basis. If this were to happen, it would be harder to achieve the medium-term inflation goal. So we need to guard against this possibility.

Moving on to our conclusion about spare capacity in the labour market.

For some years, most estimates of full employment, including our own, equated to an unemployment rate of around 5 per cent – it was thought that if unemployment went below that for too long, inflation would rise and become a problem. But, given the combination of the labour market and inflation outcomes we have seen of late, our judgement now is that we can do better than this – that we can sustain an unemployment rate of 4 point something.

It is also worth noting that the supply side of the labour market is turning out to be more flexible than we had earlier expected. The recent evidence is that when jobs are there, more people join the labour force and other Australians stay in work longer. Reflecting this, the participation rate is currently at a record high, despite demographic shifts that we anticipated would reduce participation. It is also the case that people are prepared to work extra hours when there is strong demand for their labour. Together, these observations support the conclusion that there is still spare capacity in the labour market and this is likely to remain the case for a while yet. The recent data have given us more confidence in this assessment and we have responded to this.

Over the past few years, one concern has been that lower interest rates could add to the medium-term risks facing the Australian economy as a result of high household debt. We need to keep a close eye on this issue, but this concern has receded recently. Lending practices have been tightened considerably and many lenders have become quite risk averse. The demand for credit has also slowed due to the changed dynamics of the housing market and slower income growth. So the risks on this front look to be less than they were previously.

This brings me to the second question: are interest rates going to be reduced further?

The answer here is that the Board has not yet made a decision, but it is not unreasonable to expect a lower cash rate. Our latest set of forecasts were prepared on the assumption that the cash rate would follow the path implied by market pricing, which was for the cash rate to be around 1 per cent by the end of the year. There are, of course, a range of other possible scenarios and much will depend on how the evidence evolves, especially on the labour market.

If you accept the argument that a sustainably lower rate of unemployment in Australia is achievable, the question that we should all be thinking about is: how do we get there?

It is possible that the current policy settings will be enough – that we just need to be patient. But it is also possible that the current policy settings will leave us short. Given this, the possibility of lower interest rates remains on the table. Monetary policy does have an important role to play and we have the capacity to play that role if needed.

In saying that, I also want to recognise that monetary policy is not the only option. There are certain downsides from relying just on monetary policy and there are limitations on what, realistically, can be achieved. So, as a country, we should also be looking at other options to reduce unemployment.

One option is for fiscal support, including through spending on infrastructure. This spending not only adds to demand in the economy, but it also adds to the economy’s productive capacity. So it works on both the demand and supply side.

Another option is structural policies that support firms expanding, investing, innovating and employing people.

All three options are worth thinking about.

From my perspective, the best option is the third one – structural policies that support firms expanding, investing, innovating and employing people. A strong dynamic business sector is the best way of creating jobs. Structural policies not only help with job creation, but they can also help drive the productivity growth that is the main source of improvement in our living standards. So, as a country, it is important that we keep focused on this.

I will now change tack and move to the third question: should today’s reduction in the cash rate be fully passed through to mortgage rates?

My usual practice in answering this question has been to explain that there are a range of other factors that influence mortgage pricing, and then say ‘it all depends’. There are often reasonable explanations for why the standard variable mortgage rate does not move in lock-step with the cash rate.

Today, though, I would like to break with my usual practice and provide a clearer answer. And that is: Yes, this reduction in the cash rate should be fully passed through to variable mortgage rates.

This answer is based on recent reductions in bank funding costs. Not only have these costs declined as a result of the change in monetary policy, but they have also declined because of movements in market-based spreads. Last year, these spreads increased and most lenders responded by increasing their standard variable rates by around 15 basis points. Over recent months, these spreads have reversed all the increase that occurred last year and returned to their 2017 levels. The result is that there has been a substantial reduction – at both the short end and the long end – in the cost of banks raising funds in wholesale markets. Average rates on retail deposits have also come down. This means that the lower cash rate should be fully passed through into standard variable mortgage rates. Full pass-through would also mean that the economy receives the full benefit of today’s policy decision.

That brings me to the final question: what about the savers, have we forgotten about them?

I know this question is on the minds of a lot of Australians, especially older Australians. I am reminded of this daily as people write to me telling me how the already low deposit rates are affecting their income. I am expecting to receive more such letters and emails after today’s decision.

The Board had a thorough discussion of this issue at our meeting today. We recognise that many Australians have saved hard and rely on interest from term deposits to support their income and spending. Today’s decision will reduce their income from this source and we understand why they would be disappointed with the outcome of today’s meeting.

At the same time as paying close attention to this issue, the Board considered what was best for the overall economy. Our judgement is that lower interest rates will help the economy as a whole. At the moment, this benefit is likely to come mainly through two channels. The first is a lower value of the exchange rate than otherwise would have been the case. The second is a boost to the disposable income of the household sector. In aggregate, the household sector pays around two dollars in interest for every dollar it receives in interest income. So, in aggregate, lower interest rates reduce the net interest payments of the household sector and so boost overall disposable income.

In time, we would expect the lower exchange rate and the boost to disposable income to lead to more jobs, lower unemployment and a stronger economy. This should benefit us all, although I recognise that in the short run the effects are felt unevenly across the community.

It is partly because of this unevenness that I want to repeat a point I made in answering the second question. And that is: the best approach to delivering lower unemployment and a stronger economy is through structural policies that support firms expanding, investing, innovating and employing people. These policies can have distributional effects too, but the benefits are more broadly based. So, as I said, as we ease monetary policy, it is in the country’s interest that other policy options are considered too.

RBA Cuts As Expected

The RBA has reduced the cash rate by 0.25% today as expected. Further signs of a weakening economy, exposed to the international risks which are rising.

Given the BBSW has moved towards the banks in recent times, there is no excuse not to pass the full cut to existing borrowers. The question is, will they?

The RBA will continue to look at the labour figures, which suggests a rise in unemployment (which we expect) will lead to more rate cuts.

The Aussie USD rate rose, which is not what the RBA intended.

This is what the RBA said:

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 1.25 per cent. The Board took this decision to support employment growth and provide greater confidence that inflation will be consistent with the medium-term target.

The outlook for the global economy remains reasonable, although the downside risks stemming from the trade disputes have increased. Growth in international trade remains weak and the increased uncertainty is affecting investment intentions in a number of countries. In China, the authorities have taken steps to support the economy, while addressing risks in the financial system. In most advanced economies, inflation remains subdued, unemployment rates are low and wages growth has picked up.

Global financial conditions remain accommodative. Long-term bond yields and risk premiums are low. In Australia, long-term bond yields are at historically low levels. Bank funding costs have also declined further, with money-market spreads having fully reversed the increases that took place last year. The Australian dollar has depreciated a little over the past few months and is at the low end of its narrow range of recent times.

The central scenario remains for the Australian economy to grow by around 2¾ per cent in 2019 and 2020. This outlook is supported by increased investment in infrastructure and a pick-up in activity in the resources sector, partly in response to an increase in the prices of Australia’s exports. The main domestic uncertainty continues to be the outlook for household consumption, which is being affected by a protracted period of low income growth and declining housing prices. Some pick-up in growth in household disposable income is expected and this should support consumption.

Employment growth has been strong over the past year, labour force participation has been increasing, the vacancy rate remains high and there are reports of skills shortages in some areas. Despite these developments, there has been little further inroads into the spare capacity in the labour market of late. The unemployment rate had been steady at around 5 per cent for some months, but ticked up to 5.2 per cent in April. The strong employment growth over the past year or so has led to a pick-up in wages growth in the private sector, although overall wages growth remains low. A further gradual lift in wages growth is expected and this would be a welcome development. Taken together, these labour market outcomes suggest that the Australian economy can sustain a lower rate of unemployment.

The recent inflation outcomes have been lower than expected and suggest subdued inflationary pressures across much of the economy. Inflation is still however anticipated to pick up, and will be boosted in the June quarter by increases in petrol prices. The central scenario remains for underlying inflation to be 1¾ per cent this year, 2 per cent in 2020 and a little higher after that.

The adjustment in established housing markets is continuing, after the earlier large run-up in prices in some cities. Conditions remain soft, although in some markets the rate of price decline has slowed and auction clearance rates have increased. Growth in housing credit has also stabilised recently. Credit conditions have been tightened and the demand for credit by investors has been subdued for some time. Mortgage rates remain low and there is strong competition for borrowers of high credit quality.

Today’s decision to lower the cash rate will help make further inroads into the spare capacity in the economy. It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target. The Board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time.

Retail turnover fell 0.1 per cent in April

Australian retail turnover fell 0.1 per cent in April 2019, seasonally adjusted, according to the latest Australian Bureau of Statistics (ABS) Retail Trade figures. This follows a rise of 0.3 per cent in March 2019.

The trend estimate for Australian retail turnover rose 0.2 per cent in April 2019, following a 0.2 per cent rise in March 2019. Compared to April 2018, the trend estimate rose 2.9 per cent.

  • In trend terms, Australian turnover rose 2.9% in April 2019 compared with April 2018.
  • The following industries rose in trend terms in April 2019: Food retailing (0.4%), Cafes, restaurants and takeaway food services (0.4%), Other retailing (0.1%), Department stores (0.2%), and Clothing, footwear and personal accessory retailing (0.1%). Household goods retailing (-0.2%) fell in trend terms in April 2019.
  • The following states and territories rose in trend terms in April 2019: Queensland (0.5%), New South Wales (0.2%), Victoria (0.2%), South Australia (0.3%), the Northern Territory (0.1%), and the Australian Capital Territory (0.1%). Tasmania (0.0%) was relatively unchanged. Western Australia (-0.1%) fell in trend terms in April 2019.
  • Online retail turnover contributed 5.7 per cent to total retail turnover in original terms in April 2019, which was unchanged from March 2019. In April 2018, online retail turnover contributed 5.4 per cent to total retail.