RBA Minutes Touch On Property Risks

The RBA minutes, out today, talks to risks in the housing sector.

Recent data continued to suggest that there had been a build-up of risks associated with the housing market. In some markets, conditions had been strong and prices were rising briskly, although in other markets prices were declining. In the eastern capital cities, a considerable additional supply of apartments was scheduled to come on stream over the next few years. Growth in rents had been the slowest for two decades. Borrowing for housing by investors had picked up over recent months and growth in household debt had been faster than that in household income. Supervisory measures had contributed to some strengthening of lending standards.

Dwelling investment had rebounded in the December quarter; much of the strength had been concentrated in New South Wales. Even though building approvals had fallen significantly in recent months, the substantial amount of building work in the pipeline suggested that dwelling investment would continue to contribute to growth in coming quarters. Conditions in established housing markets had continued to differ significantly across the country. Over recent months, conditions appeared to have strengthened in Sydney and had remained strong in Melbourne; these cities had continued to record brisk growth in housing prices, and auction clearance rates had remained high. Housing loan approvals and credit growth had picked up for investors, primarily in New South Wales and Victoria. In contrast, housing prices and rents had fallen in Perth for two years or so, and apartment prices had declined in Brisbane.

Rural exports had grown strongly in the December quarter, reflecting strong farm production following favourable weather conditions in many areas over the second half of 2016. As a result of this and the higher prices for bulk commodity exports, there had been a trade surplus in the December quarter for the first time in almost three years. The current account deficit had narrowed to less than 1 per cent of GDP, the smallest deficit since 1980; the trade surplus was partly offset by a widening in the net income deficit as some of the increase in mining profits had accrued to foreign owners.

Household consumption growth, which had been relatively subdued in mid 2016, picked up in the December quarter, consistent with retail sales. Liaison with retailers suggested that recent trading conditions had been around average and household perceptions of their personal finances had also been around average.

The pick-up in consumption growth stood in contrast to the ongoing weakness in labour incomes, with the household saving ratio declining in the December quarter. Members noted that over the past two decades movements in the Australian household saving ratio had been much larger than those in other similar economies. One contributing factor was likely to have been that Australia had experienced a much larger terms of trade cycle than other developed economies with significant commodity exports. Differences in the evolution of household saving ratios across the states suggested that the terms of trade had played an important role in households’ saving and spending decisions.


Wage Growth Continues To Slow

The latest edition of the RBA Bulletin included a section of wage growth and this chart. Inflation adjusted wage growth is close to zero. Not good for households with large mortgages.  Interestingly they did not separate public and private sector growth, out data suggests public sector employees are doing better than those in the private sector!

The RBA says the job-level micro WPI data provides further insights into the slowing of wage growth in Australia over recent years. Following the
decline in the terms of trade, there has been a reduction in the average size of wage increases.

This has been particularly pronounced in mining and mining-related wage industries. The increasing share of wage outcomes around 2–3 per cent also provides further support for the hypothesis that inflation outcomes and inflation expectations influence wage-setting.

The Bank’s expectation is that wage growth will gradually pick up over the next few years, as the adjustment following the end of the mining boom runs its course. The extent of the recovery will, in large part, depend on how wage growth will respond to improving labour market conditions, including the level of underutilisation.

They observe that wage growth across all pay-setting methods has declined. Wage growth in industries that have a higher prevalence of individual agreements has declined most significantly over recent years,
following strong growth in the previous few years. This may reflect the fact these industries have been influenced by the large terms of trade
movements, but may also indicate that wages set by individual contract can respond most quickly to changes in economic conditions.

Wage growth in industries with a higher share of enterprise bargaining agreements have the lowest wage volatility, as the typical length of an
agreement is around two and a half years. While changes in wage growth and labour market outcomes by pay-setting may reflect differences in wage flexibility or bargaining power, these can be difficult to distinguish from a wide range of other determinants of wages, including variation
in industry performance, the balance of demand and supply for different skills, and productivity.

The share of wage rises between 2–3 per cent has increased to now account for almost half of all wage changes. This may indicate some degree of anchoring to CPI outcomes and/or the Bank’s inflation target. Decisions by the Fair Work Commission, which sets awards and minimum wage outcomes, are heavily influenced by the CPI. A little over 20 per cent of employees have their pay determined directly by awards, and it is estimated pay outcomes for a further 10–15 per cent of employees
(covered by either enterprise agreements or individual contracts) are indirectly influenced by awards.

The US is healing but we can’t even admit we’re ill

From The NewDaily.

The Federal Reserve’s widely anticipated rate rise is a reminder that while the US has learned from its housing market crash, our political leaders have created a record bubble of mortgage debt by shying away from reform.

When Fed chair Janet Yellen announced Thursday morning (Australian time) the fed-funds rate had risen to a new target range of 0.75 to 1 per cent, it caused barely a stir in markets. The New York Stock Exchange rose 0.8 per cent, as the Fed signalled future rate rises are likely to arrive sooner than previously expected.

These days the Fed telegraphs each move so effectively that markets no longer ask ‘will they move or not?’, but more ‘does that move reflect what’s really happening in the economy?’

Yes, with its years of super low rates, the Fed did set the scene for the 2009 housing collapse that hit global markets like a tsunami. But its three rate rises since the GFC have been spot on – late enough to avoid choking the recovery, but early enough to prevent inflation getting out of hand.

At a press conference Ms Yellen said the Fed is pushing rates back towards “normal” levels because the US economy has returned to reasonable health – growing at a “moderate pace”.

Meanwhile, Australia’s rates remain at historic lows. So what are we doing wrong?

The biggest reason we’re not seeing US-style growth is, gallingly, entirely self-imposed. Our political leaders have skewed the economy heavily towards real estate investing.

The vast sums of capital tied up in housing could be establishing new businesses, or backing the expansion of existing ones. Instead, we’re a nation hypnotised by capital gains that thinks buying and selling the same houses back and forth is a productive industry.

It all began in 1999, when treasurer Peter Costello cut capital gains tax to a rate well below the personal tax rates of middle- and upper-middle class Australians. It was one of the most economically harmful policies ever dreamt up in Canberra.

It did not take the nation’s accountants long to point out to clients that investing in a property, negatively gearing it for a few years, and then banking the capital gain at the new rate would slash the investor’s tax bills.

During the same period, the US was experiencing a credit bubble for different reasons – super low rates, plus the advent of sub-prime mortgages.

When the early ‘sub-prime’ phase of the GFC finally began to be felt, US house prices tumbled. And when the sub-prime crisis worked its way through the banking system, global stock markets crashed too.

Whereas the US learned from this and started rebuilding, we arrested our correction and did everything possible to keep the credit bubble growing.

As the share market tanked in 2009, Australian policy makers decided that the sacred cow of house prices must be protected at all costs. The 2009 first home buyer’s grant kickstarted that defence, and was topped up by most state governments too.

Even though the Rudd government’s own tax review – the Henry Tax Review – had recommended reining in negative gearing and the capital gains tax discount, all that was ignored.

The tax lurks stayed, gleefully maintained by the Abbott and Turnbull governments, and the RBA joined in by cutting interest rates that blew the credit bubble larger still.

The lack of action by politicians has pushed responsibility for reining in the bubble to the Australian Prudential Regulatory Authority, which imposed a fairly weak ‘speed limit’ on credit growth two years ago.

And now the RBA itself is threatening to put more “sand in the gears” of the credit machine.

It’s all too little, too late.

Australia, having ‘escaped’ the house price collapse that swept through so many nations in 2009, is now stuck in a self-imposed debt bubble.

To Solve One Problem, Did The RBA Rate Cut Last Year Just Make Another One Worse?

From Business Insider.

When it’s all said and done, May 3, 2016, may well go down as the day when an attempt to solve a problem ended up creating an even greater one in Australia.

Six days after the release of Australia’s March quarter consumer price inflation (CPI) report — something that revealed headline CPI fell with underlying inflation also tumbling to fresh lows — the Reserve Bank of Australia (RBA) resumed a rate cutting cycle that began in late 2011, lowering the cash rate to a then record low of just 1.75%.

That reduction was followed three months later by another cut taking the cash rate to 1.5%, the level it remains at today.

Though there were other considerations, both were largely done in the name of helping to boost inflation — both near-term and in the future.

While the RBA’s response was not all that unusual — it is, after all, an inflation-targeting central bank — the twin rate cuts appear, in hindsight, may have actually created an even larger problem for the RBA.

Those cuts, along with other factors such as the Turnbull government’s reelection ending in political uncertainty over the tax treatment of housing, put a rocket under property prices in Sydney and Melbourne, already the most expensive in the country.

While there’s debate over just how much they’ve increased given varying readings from individual market providers, in simple terms the answer is a lot, in particular driven by resurgent investor activity in these markets.

It’s created a conundrum for the RBA perhaps even greater than just one year ago.

Bill Evans, chief economist at Westpac, summed up the problem perfectly earlier today.

“Even though income growth and inflation are too low and there remains ample spare capacity in the labour market the (RBA) has no flexibility to cut rates,” said Evans.

“The evidence is clear that the rate cuts the Bank embraced last year in the face of low inflation fuelled house prices and household leverage. The Bank is concerned about possible excesses in the housing market.”

Now, like then, inflation remains stubbornly low and unemployment (and especially underemployment) high, creating conditions that are leading to record-low wage growth which are then feeding back into a lack of inflationary pressures.

It’s easy to understand why some believe that the only inflation the RBA succeeded in creating was in housing prices in just two Australian cities, rather than delivering appropriate policy settings for the remainder of the country.

To be fair to the new RBA governor Philip Lowe, a man who took over that title the month after the RBA last cut rates, he’s well aware of the problem, telling parliamentarians last month that he’d like to see unemployment a bit lower and inflation a bit higher.

His reluctance to use monetary policy to speed up this trend, however, was that further rate cuts “would probably push up house prices a bit more, because most of the borrowing would be borrowing for housing.”

He’s hamstrung, in other words, as Evans suggested earlier today.

Other parts of the economy would no doubt benefit from lower borrowing costs, and potentially a lower Australian dollar, but that can’t be delivered by the RBA because of financial stability risks in Australia’s largest, most expensive and economically most important housing markets.

Though no one knows whether the RBA’s conundrum will self-correct, allowing the bank increased policy flexibility to benefit the broader Australian economy, the question that needs to be asked is whether we should wait to find out the answer.

That answer is undoubtedly no.

What is required is a coordinated response to reduce risks in the Australian housing market that will free up monetary policy to do its one and only job — to bring forward or pull back demand within the economy when necessary.

That task will fall to Australia’s banking regulator, APRA, in consultation with the RBA, along with state and federal politicians.

There’s noises being made that suggest this is already occurring, but the longer house prices in Sydney and Melbourne are allowed to run away unfettered, the greater the likelihood that the RBA will be unable to make a difference for the broader economy if and when its required.

That’s a scenario that no one wants to see tested in reality.

RBA Holds Rate — Again

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

Conditions in the global economy have continued to improve over recent months. Business and consumer confidence have both picked up. Above-trend growth is expected in a number of advanced economies, although uncertainties remain. In China, growth is being supported by higher spending on infrastructure and property construction. This composition of growth and the rapid increase in borrowing mean that the medium-term risks to Chinese growth remain. The improvement in the global economy has contributed to higher commodity prices, which are providing a significant boost to Australia’s national income.

Headline inflation rates have moved higher in most countries, partly reflecting the higher commodity prices. Long-term bond yields are higher than last year, although in a historical context they remain low. Interest rates are expected to increase further in the United States and there is no longer an expectation of additional monetary easing in other major economies. Financial markets have been functioning effectively and stock markets have mostly risen.

The Australian economy is continuing its transition following the end of the mining investment boom, expanding by around 2½ per cent in 2016. Exports have risen strongly and non-mining business investment has risen over the past year. Most measures of business and consumer confidence are at, or above, average. Consumption growth was stronger towards the end of the year, although growth in household income remains low.

The outlook continues to be supported by the low level of interest rates. Financial institutions remain in a good position to lend. The depreciation of the exchange rate since 2013 has also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment.

Labour market indicators continue to be mixed and there is considerable variation in employment outcomes across the country. The unemployment rate has been steady at around 5¾ per cent over the past year, with employment growth concentrated in part-time jobs. The forward-looking indicators point to continued expansion in employment over the period ahead.

Inflation remains quite low. With growth in labour costs remaining subdued, underlying inflation is likely to stay low for some time. Headline inflation is expected to pick up over the course of 2017 to be above 2 per cent, with the rise in underlying inflation expected to be a bit more gradual.

Conditions in the housing market vary considerably around the country. In some markets, conditions are strong and prices are rising briskly. In other markets, prices are declining. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years. Growth in rents is the slowest for two decades. Borrowing for housing by investors has picked up over recent months. Supervisory measures have contributed to some strengthening of lending standards.

Taking account of the available information the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

Lending Growth All About Housing

The latest RBA credit aggregate data shows that total lending grew in January 2017 by $14 billion, or 0.5%. Of that housing rose to $1,637.4 billion, up 1% or $15.2 billion. Business lending and unsecured personal finance fell. Clearly housing is where the action is, and given this data and strong clearances, home prices, especially in the eastern states are likely to continue to rise. It also explains the RBA’s recent comments and APRA’s tighter lending guidance. Household debt climbs ever higher, with the risks to match! No way can the RBA cut the cash rate on these numbers.

We see investment lending remained strong at $5.3 billion (0.9%) whilst owner occupied loans grew by $10 billion (1%). Investment loans were one third of all housing loans written.

The adjusted annual growth rates for housing loans was 6.4%, with owner occupied loans growing at 6.3% and investment loans 6.6%. Business lending was at 4.7% and personal credit a negative 1.3%.

The monthly movements are more noisy, but housing rose 0.5%, the same as a year ago.

The RBA notes:

All growth rates for the financial aggregates are seasonally adjusted, and adjusted for the effects of breaks in the series as recorded in the notes to the tables listed below. Data for the levels of financial aggregates are not adjusted for series breaks. Historical levels and growth rates for the financial aggregates have been revised owing to the resubmission of data by some financial intermediaries, the re-estimation of seasonal factors and the incorporation of securitisation data. The RBA credit aggregates measure credit provided by financial institutions operating domestically. They do not capture cross-border or non-intermediated lending.

Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $49 billion over the period of July 2015 to January 2017, of which $1 billion occurred in January 2017. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.

We will look at the APRA ADI data later.

Invest in Urban Transport to Fix Housing Affordability

From AAP.

Soaring household debt and housing prices could make it “dangerous” to cut interest rates, the head of the Reserve Bank of Australia says.

Dr Philip Lowe has told a Federal parliamentary economics committee that a deeper cut to the official cash rate could deliver a short-term boost to jobs and inflation but also push already-high property prices and household debt levels to worrying levels.

“Is it really in the national interest to create a little bit more employment growth in the short-run at the expense of creating vulnerabilities which could be quite dangerous in the long term,” Dr Lowe said at the hearing in Sydney on Friday.

He said another rate cut could help drive down the unemployment rate, which could be lower than its current 5.7 per cent, and boost underlying inflation, which could be higher than 1.55 per cent.

RBA figures show the household debt-to-income ratio is already at 187 per cent, while total household debt is equal to about 123 per cent of the country’s gross domestic product.

“I accept that different people will come to different points on judging that trade-off; at the moment we’re in a reasonable place because the unemployment rate is broadly steady and household debt and house price growth at the aggregate level are fast enough,” Dr Lowe said.

“I feel if they were even faster at the moment we would be moving into the area where the vulnerabilities are increasing, perhaps to unacceptable levels.”

Lower housing prices and household debt levels would only marginally strengthen the case for another rate cut, he said.

The central bank chief said monetary policy alone could no longer drive growth and it was up to the Parliament to use fiscal policy — through changes to tax and spending — to support the economy.

“Monetary policy at the margin can help you, but were talking very much at the margin,” he said.

The best way the Government could reduce pressure on property prices and boost growth would be investing in urban transport infrastructure, he said.

He said with a growing population, crowded cities, poor land supply and the difficulties people encounter moving around, investment in urban transport infrastructure would be “a first order gain”.

“It increases demand, takes the pressure off ultra-low interest rates, increases the productive capacity of the economy because people can move around, it takes the pressure off housing prices,” Dr Lowe.

“It’s probably the best housing affordability policy.”

Household Debt Has Become An RBA Thematic

The statement delivered today by RBA Governor, Philip Lowe, to the House of Representatives Standing Committee on Economics contains the now familiar nod towards risks associated with high household debt.  “Too much borrowing today can create problems for tomorrow, because debt does have to be repaid”. Exactly!

One area that we are watching closely is the cycle in residential construction activity, as the upswing has helped support the economy over recent years. The rate of new building approvals has slowed, but there is a large amount of work still in the pipeline, particularly for apartments, so we still expect some further growth in this part of the economy this year. There has, however, been some tightening in conditions for property developers in some markets.

In the broader housing market, the picture remains quite complicated. There is not a single story across the country. In parts of the country that have been adjusting to the downswing in mining investment or where there have been big increases in supply of apartments, housing prices have declined. In other parts, where the economy has been stronger and the supply-side has had trouble keeping up with strong population growth, housing prices are still rising quickly. In most areas, growth in rents is low. And recently we have seen a pick-up in growth in credit to investors, which needs to be watched carefully.

In terms of consumer prices, a year ago we had expected the inflation rate to remain above 2 per cent. It has turned out to be lower than this last year, at around 1½ per cent. Wage growth has been quite subdued, reflecting spare capacity in the labour market and the adjustment to the unwinding of the mining investment boom. We anticipate the subdued outcomes to continue for a while yet. Increased competition in retailing is also having an effect on prices, as is the low rate of increase in rents.

We do not expect the rate of inflation to fall further. Our judgement is that there are reasonable prospects for inflation to rise towards the middle of the target over time. The recent improvement in the global economy provides some extra assurance on this front. Headline inflation is expected to be back above 2 per cent later this year, boosted by higher prices for petrol and tobacco. The pick-up in underlying inflation is expected to be more gradual.

Since we appeared before this Committee last September, the Reserve Bank Board has kept the cash rate unchanged at 1.5 per cent.

At its recent meetings the Board has been paying close attention to the outlook for inflation as well as two other issues: trends in household borrowing and in the labour market.

One of the ways in which monetary policy works is to make it easier for people to borrow and spend. But there is a balance to be struck. Too much borrowing today can create problems for tomorrow, because debt does have to be repaid. At the moment, most households with borrowings do seem to be coping pretty well. But the current high level of debt, combined with low nominal income growth, is affecting the appetite of households to spend, and we are seeing some evidence of this in the consumption figures. The balance that is required is to support spending in the economy today while avoiding creating fragilities in household balance sheets that could cause problems for the economy later on. This is also something we need to watch carefully.

Trends in the labour market are also important. As in the housing market, the picture in the labour market varies significantly around the country. Overall, the unemployment rate has been steady now for a little over a year at around 5¾ per cent. In a historical context this would have been considered a good outcome, although, today, a sustainably lower unemployment rate should be possible in Australia. The other aspect of the labour market that is worth noting is the continuing trend towards part-time employment. Over the past year, all the growth in employment is accounted for by part-time jobs. There is a structural element to this, but it is also partly cyclical. We expect that the unemployment rate will remain around its current level for a while yet.

The Reserve Bank Board continues to balance these various issues within the framework of our flexible medium-term inflation target, which aims to achieve an average rate of inflation over time of 2 point something. Our judgement is that the current setting of the cash rate is consistent with both this and achieving sustainable growth in our economy. We will continue to review that judgement at future meetings.

There’s Never Been a Tougher Time to be a Central Banker

From The Conversation.

The two central banks that matter most for Australians – the Reserve Bank of Australia (RBA) and the US Federal Reserve (the Fed) – released minutes from their latest meetings this week. And although there were not a lot of surprises, there was a fair bit of detail about what we can expect on interest rates going forward.

The Federal Open Market Committee’s (FOMC) main message was unmistakable -expect interest rate rises, and expect them sooner rather than later:

Many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the committee’s maximum-employment and inflation objectives increased.

and that they:

continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer-run normal level and inflation pressures would increase significantly.

This is exactly what markets have been expecting, and it seems clear that the balance of risks is no longer that the labour market is too weak or inflation too low, but that the Fed might wait too long to continue its path of rate rises.

The really big unknown is how the Fed goes about unwinding a good chunk of its balance sheet, which involves US$2.64 trillion (with a “T”) of treasury bonds that were purchased as part of its effort to stimulate the economy in the wake of the financial crisis. The Fed also holds around US$1.75 trillion of mortgage-backed securities (“MBSs”).

The natural way to unwind this is by not reinvesting those funds when the securities mature. The Fed gets its money back and doesn’t purchase new treasuries or MBSs.

But it’s more complicated than that. New post-crisis capital rules require commercial banks to keep a large amount of reserves sitting at the Fed. This is now around US$2 trillion. The Fed has to match this liability with assets, like treasuries.

Nobody knows, but my guess is that the Fed shifts MBSs to treasuries over time, but has to keep a large asset side of the balance sheet. This suggests that maybe the whole balance sheet unwinding problem may not be as significant an issue as first thought. But this is genuinely unchartered territory.

At home, the RBA minutes confirmed the ongoing dilemma governor Philip Lowe faces. Like his predecessor, Glenn Stevens, Lowe is trying to manage: unemployment, the Aussie dollar exchange rate, business investment, overall growth, inflation and housing price stability all at the same time, but with only one instrument: the cash rate.

To see this, just look at the opening sentences of the long section of the RBA minutes titled “Considerations for Monetary Policy”. They read as follows:

In considering the stance of monetary policy, members viewed the near-term prospects for global growth as being more positive, although recognised the risks from policy uncertainty in the medium term… Domestically, the economy was continuing its transition following the end of the mining investment boom… Non-mining business investment was also expected to gain some momentum…

Conditions in housing markets varied considerably across the country… Inflation outcomes for the December quarter were much as had been expected and there had been very little change to the forecast for inflation…Labour cost pressures were expected to build gradually from their current low levels…

Wow. That’s a whole lot of targets to try and hit with a single (non-magic, non-silver) bullet. No wonder Dr Lowe has now taken to giving speeches that essentially plead businesses to invest.

It hasn’t quite gotten to “there’s never been a better time to be a business in Australia”. But close. It may, however, be that it’s never been a tougher time to be a governor of the RBA.

Author: Richard Holden , Professor of Economics and PLuS Alliance Fellow, UNSW