In the halcyon days of February (remember when the stock markets hit all time highs), total mortgage lending growth from the banks was already weak, with investment lending balances falling slightly, and owner occupied lending growing, on a net basis. Some of this was driven by households choosing to pay down loans thanks to their own financial uncertainty. This could have proved to be very smart. The share of investment mortgages in the portfolio dropped to 36.8%, with the total exposures up to $1.75 trillion dollars, with owner occupied loans at $1.10 trillion and investment loans $0.64 trillion.
In percentage terms, investment balances fell by 0.03% or $170 million and owner occupied loans rose 0.3% or $3.3 billion, giving total loan growth of 0.18% or $3.17 billion. Ahead of course, interest will be rolled up into balances for the duration, but the number of new mortgages may slow. Hard to predict, as some seek to switch loans, or even sell quickly.
Portfolio movements within the banks, as reported by APRA, is subject to a range of potential input errors. but with that caveat it seems that CBA, Macquarie, Bendigo and HSBC were lending more freely, while NAB and Westpac saw their investor balances fall, whereas ANZ dropped both sets of balances. ING and Bank of Queensland dropped investor loans, while Suncorp dropped owner occupied balances while growing investor loan balances once again.
Meantime, the RBA aggregate figures are also out today. They reported total credit grew 0.4% in February, and 2.8% over the year, compared to 4.1% a year before. More signs of slowing.
Within that, lending for housing rose 0.3% in February to 3.2% over the year, compared with 4.2% a year ago. Business lending rose 0.9% in February to reach 3.5% over the year, compared with 5.1% a year back. And personal credit dropped 0.5% in February, and is down 5.3% over the year, compared with down 2.6% the previous year.
More granular analysis shows that lending for owner occupation is where the growth is, at 5.1% annualised, up from a low of 4.8% back in October last year, so hardly a stellar recovery. Investment lending is still falling slightly.
Broad money is falling, down to 4.1% annualised, despite the rise in credit. All signs of weakness before the current health crisis is freezing the economy.
All pretty academic now, but there is the data for the record!
Phil Lowe gave an important speech yesterday outlining their monetary policy response. “At some point, the virus will be contained and our economy and our financial markets will recover”. We are going to hear a lot more about bridges and cushions.
The Reserve Bank Board met yesterday and decided on a comprehensive package to help support jobs, incomes and businesses as the Australian economy deals with the coronavirus. I would like to use this opportunity to explain this package and to answer your questions.
We are clearly living in extraordinary and challenging times. The coronavirus is first and foremost a very
major public health problem. But it has also become a major economic problem, which is having deep
ramifications for financial systems around the world. The closure of borders and social distancing measures
are affecting us all and they are changing the way we live. Understandably, our communities and our
financial markets are both having trouble dealing with a rapidly unfolding situation that they have not seen
before.
As our country manages this difficult situation, it is important that we do not lose sight of the fact that
we will come through this.
At some point, the virus will be contained and our economy and our financial markets will recover.
Undeniably, what we are facing today is a very serious situation, but it is something that is temporary. As
we deal with it as best we can, we also need to look to the other side when things will recover. When we do
get to that other side, all those fundamentals that have made Australia such a successful and prosperous
country will still be there. We need to remember that.
To help us get to the other side, though, we need a bridge. Without that bridge, there will be more damage, some of which will be permanent, to the economy and to people’s lives.
Building that bridge requires a concerted team effort, with us all pulling together in the country’s
interest. On the economic front, there is very close policy coordination between the Australian Government,
the Australian Treasury, the Reserve Bank and Australia’s financial regulators. We are all in close contact
with one another and are working constructively together and we will continue to do so. This coordination is
evident in the various policy statements today.
Governments across Australia are playing their important role in building that bridge to the recovery, with
the various fiscal initiatives from the Australian and state governments providing very welcome support.
Rightly, the focus is on supporting businesses and households who will suffer a major hit to their incomes.
It is increasingly clear that further help will be required on this front and the Australian Government has
indicated that additional policy measures will be announced shortly. Australian public finances are in good
shape and the country’s history of prudent fiscal management gives us the capacity to respond now.
The banks too have an important role to play in building that bridge to the recovery by supporting their
customers. Without this support, it will be harder for us all to get to the other side in reasonable shape.
Australia has a strong financial system, which is well placed to provide the needed support to businesses and
households. The system has strong capital and liquidity positions and our financial institutions have
invested heavily in resilience. As APRA confirmed this afternoon in a public statement, the current large
buffers of capital and liquidity are able to be used to support ongoing lending to the economy.
The financial regulators have also confirmed that they are examining how the timing of various regulatory
initiatives might be adjusted to allow financial institutions to concentrate on their businesses and work
with their customers. APRA and ASIC both stand ready to assist institutions work through regulatory issues
arising from the virus. The Council of Financial Regulators is meeting again tomorrow and will also meet
with the largest lenders to discuss how they can support their customers and whether there are any
regulatory impediments in the way.
The Reserve Bank itself is also playing a role in building that bridge to the recovery. I will now turn to
that.
Our major focus is to support jobs, incomes and businesses, so that when the health crisis recedes the
country is well placed to recover strongly. Supporting small business over coming months is a particular
priority.
Prior to today’s announcement, we had already taken several steps over recent days to support the Australian
economy.
Over the past week or so we have been injecting substantial extra liquidity into the financial system through
our daily market operations. As part of this effort, we will be conducting one-month and three-month repo
operations each day. We will also conduct repo operations of six-month maturity or longer at least weekly,
as long as market conditions warrant. As a result of these liquidity operations, Exchange Settlement
balances have increased from around $2.5 billion a month ago to over $20 billion today.
The Reserve Bank also stands ready to purchase Australian government bonds in the secondary market to support
its smooth functioning. The government bond market is a key market for the Australian financial system,
because government bonds provide the pricing benchmark for many financial assets. Our approach here is
similar in concept to our longstanding approach to the foreign exchange market, where we have been prepared
to support smooth market functioning when liquidity conditions are highly stressed. We now stand ready to do
the same in the bond market and we are working in close cooperation on this with the Australian Office of
Financial Management (AOFM).
In addition to these previously announced measures, today’s package has four elements. They are: a reduction
in the cash rate to 0.25 per cent; a target of 0.25 per cent for the yield on 3-year government bonds; a
term funding facility to support credit to businesses, particularly small and medium-sized businesses; and
an adjustment to the interest rate on accounts that financial institutions hold at the RBA.
I will discuss each of these in turn.
1. A Further Reduction in the Cash Rate to ¼ Per Cent
This brings the cumulative decline over the past year to 1¼ percentage points. This is a substantial easing
of monetary policy, which is boosting the cash flow of businesses and the household sector as a whole. It is
also helping our trade-exposed industries through the exchange rate channel. At the same time, though, low
interest rates do have negative consequences for some people, especially those relying on interest income.
The Reserve Bank Board has discussed these consequences extensively, but the evidence is that lower interest
rates do benefit the community as a whole, although I acknowledge that the effects are uneven.
With this decision today, the policy rates set by the Reserve Bank of Australia, the United States Federal
Reserve, the Bank of England and the Reserve Bank of New Zealand are all effectively at ¼ per cent. Each of
us are using all the scope we have with interest rates to support our economies through a very challenging
period.
At its meeting yesterday, the Board also agreed that we would not increase the cash rate from its current
level until progress was made towards full employment and that we were confident that inflation will be
sustainably within the 2–3 per cent range. This means that we are likely to be at this level of interest
rates for an extended period.
Before the coronavirus hit, we were expecting to make progress towards full employment and the inflation
target, although that progress was expected to be only very gradual. Recent events have obviously changed
the situation and we are now likely to remain short of those objectives for somewhat longer.
I am not able to provide you with an updated set of economic forecasts. The situation is just too fluid. But
we are expecting a major hit to economic activity and incomes in Australia that will last for a number of
months. We are also expecting significant job losses. The scale of these losses will depend on the ability
of businesses to keep workers on during this difficult period. We saw during the global financial crisis how
flexibility in working arrangements limited job losses and this benefited the entire community. I hope the
same is true in the months ahead.
It is also important to repeat that we are expecting a recovery once the virus is contained. The timing and
strength of that recovery will depend in part upon how successful we are, as a nation, in building that
bridge to the other side. When that recovery does come, it will be supported by the low level of interest
rates. We will maintain the current setting of interest rates until a strong recovery is in place and the
achievement of our objectives is clearly in sight.
2. A Target Yield on 3-year Australian Government Bonds
Over recent decades, the Reserve Bank’s practice has been to target the cash rate, which forms the anchor
point for the risk-free term structure. We are now extending and complementing this by also targeting a
risk-free interest rate further out along the yield curve.
In particular, we are targeting the yield on 3-year Australian Government Securities (AGS) and we have set
this target at around 0.25 per cent, the same as the cash rate. Over recent weeks, the yield on 3-year AGS
has averaged 0.45 per cent, so this represents a material reduction.
We have chosen the three-year horizon as it influences funding rates across much of the Australian economy
and is an important rate in financial markets. It is also consistent with the Board’s expectation that the
cash rate will remain at its current level for some years, but not forever.
To achieve this yield target, we will be conducting regular auctions in the bond market. We published some
technical details earlier today and we will keep the market informed of our operations. Our first auction
will be tomorrow. As part of this program, our intention is to purchase bonds of different maturities given
the high level of substitutability between bonds. We are also prepared to buy semi-government securities to
achieve the target and to help facilitate the smooth functioning of Australia’s bond market.
I want to make it clear that our purchases will be in the secondary market and we will not be purchasing
bonds directly from the Government.
I would also like to emphasise that we are not seeking to have the three-year yield identically at 25 basis
points each and every day. There will be some natural variation, and it does not make sense to counter that.
It may also take some time for yields to fall from their current level to 25 basis points.
I understand why many people will view this as quantitative easing – or QE. This is because there is a
quantitative aspect to what we are doing – achieving this target will involve the Reserve Bank buying bonds
and an expansion of our balance sheet.
But our emphasis is not on the quantities – we are not setting objectives for the quantity and timing of
bonds that we will buy, as some other central banks have done. How much we need to purchase, and when we
need to enter the market, will depend upon market conditions and prices.
Rather than quantities or the size of our balance sheet, our focus is very much on the price of money and
credit. Our objective here is to provide support for low funding costs across the entire economy. By
lowering this important benchmark interest rate, we will add to the downward pressure on borrowing costs for
financial institutions, households and businesses. We are prepared to transact in whatever quantities are
necessary to achieve this objective.
We expect to maintain the target for three-year yields until progress is being made towards our goals of full
employment and the inflation target. Our expectation, though, is that the yield target will be removed
before the cash rate is increased.
3. A Term Funding Facility for the Banking System with Support for Business Credit, Especially to Small and
Medium-sized Businesses
The scheme has two broad objectives.
The first is to lower funding costs for the entire banking system so that the cost of credit to households
and businesses is low. In this regard, it will complement the target for the three-year yield on AGS.
The second objective is to provide an incentive for lenders to support credit to businesses, especially small
and medium-sized businesses. This is a priority area for us. Many small businesses are going to find the
coming months very difficult as their sales dry up and they support their staff. Assisting small businesses
through this period will help us make that bridge to the other side when the recovery takes place. If
Australia has lost lots of otherwise viable businesses through this period, making that recovery will be
harder and we will all pay the price for that. So it is important that we address this.
Under this new facility, authorised deposit-taking institutions (ADIs) in total will have access to at least
$90 billion in funding. ADIs will be able to borrow from the Reserve Bank an amount equivalent to 3 per cent
of their existing outstanding credit to Australian businesses and households. ADIs will be able to draw on
these funds up until the end of September this year.
Lenders will also be able to borrow additional funds from the Reserve Bank if they increase credit to
business this year. For every extra dollar lent to large business, lenders will have access to an additional
dollar of funding from the Reserve Bank. For every extra dollar of loans to small and medium-sized
businesses they will have access to an additional five dollars. These funds can be drawn upon up until the
end of March next year. There is no extra borrowing allowance for additional housing loans.
The funding from the Reserve Bank will be for three years at a fixed interest rate of 0.25 per cent, which is
substantially below lenders’ current funding costs. Institutions accessing this scheme will need to provide
the usual collateral to the Reserve Bank, with haircuts applying. The first drawings under this facility
will be possible no later than four weeks from today.
This scheme is similar to that introduced by the Bank of England. Unlike the Bank of England’s scheme,
though, the interest rate is fixed for the term of the funding. This is consistent with our view that the
cash rate is likely to stay at its current level for some time. Another difference with the Bank of
England’s scheme is that we have not included a higher interest rate if credit contracts. While a decline in
credit would be undesirable, including a penalty may act as a disincentive for institutions to take part in
the scheme.
We are encouraging all ADIs to use the term funding facility to help support their customers. I welcome
APRA’s confirmation this afternoon that it also supports ADIs using this scheme. I also welcome the
Australian Government’s announcement that it will support the markets for asset-backed securities through
the AOFM. This support is important as it will help non-bank financial institutions and small lenders to
continue to provide credit to Australian households and businesses.
4. An Adjustment to the Interest Rate on Exchange Settlement Balances
Under our longstanding framework, the RBA operates a corridor system around the cash rate. Under that system,
the balances that banks hold with the RBA overnight in Exchange Settlement accounts earn an interest rate 25
basis points below the cash rate. And on the other side of the corridor, in the event that a bank needed to
borrow from the RBA overnight, it would be charged 25 basis points above the cash rate.
Under this arrangement and with the cash rate now at 25 basis points, the interest rate on Exchange
Settlement balances would have been zero. We have decided to increase this to 10 basis points. We are not
making any change to the arrangements for the top of the corridor.
This adjustment to the corridor reflects the fact that there will be a significant increase in the balances
held in Exchange Settlement accounts due to the combined effect of the Bank’s enhanced liquidity operations,
bond purchases and term funding program. Maintaining a zero interest rate on these balances would increase
the costs to the banking system. In the current environment, this would be unhelpful.
The increase in settlement balances is also expected to change the way that the cash market operates. In
other countries, where there have been large increases in balances at the central bank, the cash rate
equivalent has drifted below the target and transaction volumes in the cash market have declined. It is
likely that we will see the same outcome in Australia. The Reserve Bank will continue to monitor the cash
market closely and is prepared to adjust arrangements if the situation requires.
So these are the four measures announced earlier this afternoon. Together, they represent a comprehensive
package to lower funding costs in Australia and support the supply of credit. Complementary initiatives by
APRA and the AOFM are also working towards those same objectives.
The term funding scheme and the three-year yield target are both significant policy developments that would
not have been under consideration in normal times. They both carry financial and other risks for the Reserve
Bank and they both represent significant interventions by the Bank in Australia’s financial markets.
The Reserve Bank Board did not take these decisions lightly. But in the context of extraordinary times and
consistent with our broad mandate to promote the economic welfare of the people of Australia, we are seeking
to play our full role in building that bridge to the time when the recovery takes place. By doing all that
we can to lower funding costs in Australia and support the supply of credit to business, we will help our
economy and financial system get through this difficult period.
RBA said: The coronavirus is first and foremost a public health issue, but it is also having a very major impact on the economy and the financial system. As the virus has spread, countries have restricted the movement of people across borders and have implemented social distancing measures, including restricting movements within countries and within cities. The result has been major disruptions to economic activity across the world. This is likely to remain the case for some time yet as efforts continue to contain the virus.
Financial market volatility has been very high. Equity prices have experienced large declines.
Government bond yields have declined to historic lows. However, the functioning of major government bond
markets has been impaired, which has disrupted other markets given their important role as a financial
benchmark. Funding markets are open to only the highest quality borrowers.
The primary response to the virus is to manage the health of the population, but other arms of policy,
including monetary and fiscal policy, play an important role in reducing the economic and financial
disruption resulting from the virus.
At some point, the virus will be contained and the Australian economy will recover. In the interim, a
priority for the Reserve Bank is to support jobs, incomes and businesses, so that when the health crisis
recedes, the country is well placed to recover strongly.
At a meeting yesterday, the Reserve Bank Board agreed to the following comprehensive package to support
the Australian economy through this challenging period:
A reduction in the cash rate target to 0.25 per cent.
The Board will not increase the cash rate target until progress is being made towards full employment
and it is confident that inflation will be sustainably within the 2–3 per cent target
band.
A target for the yield on 3-year Australian Government bonds of around 0.25 per cent.
This will be achieved through purchases of Government bonds in the secondary market. Purchases of
Government bonds and semi-government securities across the yield curve will be conducted to help
achieve this target as well as to address market dislocations. These purchases will commence tomorrow.
The Bank will work closely with the Australian Office of Financial Management (AOFM) and state
government borrowing authorities to ensure the efficacy of its actions. Further details about the
implementation of this are provided in the accompanying notice.
A term funding facility for the banking system, with particular support for credit to small and
medium-sized businesses.
The Reserve Bank will provide a three-year funding facility to authorised deposit-taking institutions
(ADIs) at a fixed rate of 0.25 per cent. ADIs will be able to obtain initial funding of up to
3 per cent of their existing outstanding credit. They will have access to additional funding
if they increase lending to business, especially to small and medium-sized businesses. This facility is
for at least $90 billion. Further details are available in the accompanying notice.
The Australian Government has also developed a complementary program of support for the non-bank
financial sector, small lenders and the securitisation market, which will be implemented by the
AOFM.
Exchange settlement balances at the Reserve Bank will be remunerated at 10 basis points, rather
than zero as would have been the case under the previous arrangements.
This will mitigate the cost to the banking system associated with the large increase in banks’
settlement balances at the Reserve Bank that will occur following these policy actions.
The Reserve Bank will also continue to provide liquidity to Australian financial markets by
conducting one-month and three-month repo operations in its daily market operations until further
notice. In addition, the Bank will conduct longer-term repo operations of six-month maturity or longer
at least weekly, as long as market conditions warrant.
The various elements of this package reinforce one another and will help to lower funding costs
across the economy and support the provision of credit, especially to small and medium-sized
businesses.
Australia’s financial system is resilient and well placed to deal with the effects of the
coronavirus. The banking system is well capitalised and is in a strong liquidity position. Substantial
financial buffers are available to be drawn down if required to support the economy. The Reserve Bank is
working closely with the other financial regulators and the Australian Government to help ensure that
Australia’s financial markets continue to operate effectively and that credit is available to
households and businesses.
Today’s policy package from the Reserve Bank complements the welcome fiscal response from
governments in Australia. Together, these measures will support jobs, incomes and businesses through
this difficult period and they will also assist the Australian economy in the recovery.
As Australia’s financial system adjusts to the coronavirus (COVID-19), financial
regulators and the Australian Government are working closely together to help ensure
that Australia’s financial markets continue to operate effectively and that credit
is available to households and businesses. (Refer to earlier Council of Financial Regulators’ (CFR)
press release.)
Australia’s financial system is resilient and it is well placed to deal with the
effects of the coronavirus. At the same time, trading liquidity has deteriorated in some
markets.
In response, the Reserve Bank stands ready to purchase Australian government bonds in
the secondary market to support the smooth functioning of that market, which is a key
pricing benchmark for the Australian financial system. The Bank will also be conducting
one-month and three-month repo operations in its daily market operations until further
notice to provide liquidity to Australian financial markets. In addition the Bank will
conduct longer term repo operations of six-months maturity or longer at least weekly, as
long as market conditions warrant. The Reserve Bank and the AOFM are in close liaison in
monitoring market conditions and supporting continued functioning of the market.
The Bank will announce further policy measures to support the Australian economy on Thursday.
DFA is expecting a 0.25% rate cut, and formal QE to go alongside the repo operations already in train.
Australia’s
financial system is resilient and it is well placed to deal with the effects of
COVID-19. The banking system is well capitalised and is in a strong liquidity
position. Substantial financial buffers are available to be drawn down if
required to support the economy.
The
funding position of the banking system is strong. Australia’s financial
institutions, market participants and market infrastructure providers have
undertaken substantial investments in their operational capability to deal with
the effects of the virus. At the same time, trading liquidity has deteriorated
in some markets and financial institutions are having to adjust to a more
volatile environment. The financial regulators are in regular contact with
financial institutions, market participants and market infrastructure
providers.
The RBA is continuing to support the liquidity of the system. As part of this support it will be conducting one-month and three-month repurchase (repo) operations until further notice. In addition it will conduct repo operations of six-months maturity or longer at least weekly, as long as market conditions warrant. The Australian Prudential Regulation Authority (APRA) is ensuring banking institutions pre-position themselves to take advantage of the RBA’s supportive measures.
Given the
disruption being caused by COVID-19, Council members are examining how the
timing of regulatory initiatives might be adjusted to allow financial
institutions to concentrate on their businesses and assist their customers.
APRA and
ASIC acknowledge the importance of the continued flow of credit to affected
customers and industries in the current environment. Banks and other lenders
are therefore encouraged to work constructively with affected customers during
any period of disruption. For their part, APRA and ASIC will take account of
the circumstances in which lenders, acting reasonably, are currently operating
during the prevailing circumstances when administering their respective laws
and regulations. Both agencies also stand ready to deal with problems firms may
encounter in complying with the law due to the impact of COVID-19 through
a facilitative and constructive approach. In particular, each agency will,
where warranted, provide relief or waivers from regulatory requirements. This
includes requirements on listed companies associated with secondary capital
raisings, annual general meetings and audits. ASIC will also work with
financial institutions to further accelerate the payment of outstanding
remediation to customers as soon as possible.
The
Council is meeting with major lenders later this week to discuss how they can
best support households and businesses through this challenging period. The
Council will be emphasising the importance of a continuing supply of credit,
particularly to small businesses. It will be also discussing with the lenders
whether there are impediments to lending that Council members could help to
address.
The
members of the Council of Financial Regulators remain in close contact with one
another and with the Australian Government and their international peers. The
Council will have its regular quarterly meeting on Friday 20 March at
which the impact of COVID-19 on the financial system will be further
discussed. The Council and the Australian Treasurer are also holding
teleconferences at least weekly.
Council of Financial Regulators
The Council
of Financial Regulators (the Council) is the coordinating body for Australia’s
main financial regulatory agencies. There are four members: the Australian
Prudential Regulation Authority (APRA), the Australian Securities and
Investments Commission (ASIC), the Australian Treasury and the Reserve Bank of
Australia (RBA). The Reserve Bank Governor chairs the Council and the RBA
provides secretariat support. It is a non-statutory body, without regulatory or
policy decision-making powers. Those powers reside with its members. The
Council’s objectives are to promote stability of the Australian financial
system and support effective and efficient regulation by Australia’s financial
regulatory agencies. In doing so, the Council recognises the benefits of a competitive,
efficient and fair financial system. The Council operates as a forum for
cooperation and coordination among member agencies. It meets each quarter, or
more often if required.
Local bond market sources reported an evaporation of liquidity, heavy selling pressure, clogged dealer balance sheets and upward pressure on government bond yields in global government bond markets, including the US and Australia.
“There’s heavy selling of bank bill futures, a bit like the GFC,” a trader said.
RBA Deputy Governor Guy Debelle gave a keynote Address at the Australian Financial Review Business Summit. It was a summary of how the Bank is seeing developments in the economy at the moment. As normal, the story was the economy was doing quite well, until the onset of the coronavirus. And once it passes things will revert to this trend.
They admit that the global economy will be materially weaker in the first quarter of 2020 and in the period ahead. Australia will see at least a 0.5% fall in growth in the current quarter, but it is just too uncertain to assess the impact of the virus beyond the March quarter, he said. Despite the fact that spreads on Australian bank bonds have widened, yields remain at levels that are still very low historically, and banks are strongly capitalised.
Weirdly, he fails to discuss the Fed’s ongoing repo operations and growing balance sheet. John Adams and I released a show on this just today:
Here is the speech in full:
The December quarter national accounts confirmed our assessment that the Australian economy ended 2019
with a gradual pick-up in growth. Growth over the year was 2¼ per cent, up from a low of
1½ per cent. Consumption growth was a little stronger in the quarter, although still
subdued. We had estimated that the bushfires will subtract around 0.2 percentage points from growth
across the December and March quarters, but besides that, economic growth was set to continue to pick up
supported by low interest rates, the lower exchange rate, a rise in mining investment, high levels of
spending on infrastructure and an expected recovery in residential construction.
On the global side, around the turn of the year there were indications that the global economy was
coming out of a soft patch of growth. The trade tensions between China and the US had abated, surveys of
business conditions were picking up and industrial production was improving. Financial conditions were
very stimulatory and supporting the pick-up in global growth.
Since then, there is no doubt that the outbreak of the virus has significantly disrupted this momentum,
initially in China and now more broadly. We do not have a clear picture yet on the disruption to the
Chinese economy caused by the virus and the measures put in place to contain the virus. But the
following two graphs provide some sense of the significant disruption to the Chinese people and
economy.
The coal consumption graph (Graph 1) shows the regular significant decline in production around
Chinese New Year. But this year, the return to normal production has been significantly delayed. There
was no ramp up in production after the holiday period, and we are now more than four weeks past the
point where the Chinese economy is normally back to full-scale production. The straight arithmetic of
losing a substantial amount of output over a period of several weeks implies a significant hit to
economic activity. The road congestion graph (Graph 2) tells a similar story of a protracted period
of low output.
Both show that the Chinese economy is now only gradually returning to normal. Even as this occurs, it
is very uncertain how long it will take to repair the severe disruption to supply chains.
In the meantime, the virus has spread to other countries. They too are beginning to suffer significant
disruptions, the extent and duration of which is unknown at this time.
The conclusion is that the global economy will be materially weaker in the first quarter of 2020 and in
the period ahead.
In terms of the effect on the Australian economy, we have estimated the direct impact on the education
and tourism sectors in the March quarter. Graph 3 shows the normal profile of visitor arrivals into
Australia. Since January, inbound airline capacity from China has declined by 90 per cent,
which gives a guide to the size of the decline in arrivals from China. Up until recently, tourist
arrivals from other countries had held up reasonably well but that may no longer be true. From our
liaison with the education sector, including the universities, as well as student visa numbers, we have
information on the number of foreign students who have been unable to resume their studies. Graph 4
shows the country of origin of foreign students in Australia.
We have used this information to estimate the impact of the virus in these two sectors of the economy.
The estimate is approximate, but at this stage we think the decline in services exports in the March
quarter will amount to at least 10 per cent, roughly evenly split between lower tourism and
education exports. As service exports account for 5 per cent of GDP, this translates into a
subtraction from growth of ½ per cent of GDP in the March quarter from these two
sources.
Through our business liaison program we are gathering information on supply chain disruptions which are
affecting the construction and retail sectors in particular. Clearly we are still only in the early
weeks of March, so the picture can change from here.
It is just too uncertain to assess the impact of the virus beyond the March quarter.
Our liaison with the resources sector does not indicate any material disruption to exports of iron ore
and coal at this stage. Indeed, iron ore and coal prices have been resilient. Disruptions to Chinese
domestic production of iron ore and coal have been a factor in this, which has resulted in more use of
imported resources. Another is the expectation that the Chinese policy response will involve a
significant amount of infrastructure spending which will benefit bulk commodities. The movements in
these commodity prices stand in contrast to the large decline in the oil price, which will flow through
to LNG prices (Graph 5).
I will now summarise recent developments in financial markets. There has been a large increase in risk
aversion and uncertainty. The virus is going to have a material economic impact but it is not clear how
large that will be. That makes it difficult for the market to reprice financial assets.
Policy interest rates have been reduced in some countries, including Australia, and further reductions
are expected where that is possible. Currently market pricing implies a reduction of between 75 and
100 basis points in the Fed’s policy rate at their meeting next week.
Government bond yields have declined to historic lows, because of the shift downwards in actual and
expected policy rates, reduced expectations for growth and a flight to safety (Graph 6). The
25 per cent fall in oil prices on Monday morning has also led to lower expectations of
inflation. The 10 year US treasury yield reached a low below 35 basis points on Monday,
including a 25 basis point decline at the opening of trade in Asia. It has since risen to be around
65 basis points at the time of writing.
Australian government bond yields have been driven by the global developments. They haven’t
declined as much as US Treasuries, such that the spread between the 10 year yields is now slightly
positive, having been negative over the past two years. At the time of writing, the Australian
government can borrow for 10 years at 75 basis points.
Equity prices have fallen by as much as 20 per cent since their all-time peak of less than a
month ago, although the Australian market rebounded on Tuesday (Graph 7). The falls have been
particularly large for companies in the oil sector, as well as tourism.
Corporate bond spreads have widened. Through the first part of this move, the widening in large part
reflected the rapid shift downwards in the risk free (government bond) curve. Investment grade bond
spreads widened but investment grade yields actually fell (Graph 8). In the last few days though,
we have seen yields rise along with the spreads. The high yield sector has seen a marked rise in yields
and spreads, particularly in the US reflecting the prevalence of energy companies in that market. Bond
issuance has been extremely low, in part because issuers do not want to appear to be in desperate need
of funds in a dislocated market. It is also worth noting that just as equities prices have fallen from
historic highs, so too have corporate bond prices fallen from historic highs.
Liquidity in fixed income markets has been poor at times, including in US Treasuries. The liquidity
environment has changed considerably in the past decade in response to changed regulations. The banking
sector is much less willing and able to warehouse risk and provide liquidity than in the past.[2]
The Australian banking system is well capitalised and is in a strong liquidity position. The Australian
banks had raised a significant amount of wholesale funding before the disruption to markets and deposit
inflows are robust. They are resilient to a period of market disruption. Spreads on Australian bank
bonds have widened, although yields remain at levels that are still very low historically. We have not
seen any particular sign of pressure in our daily market operations to date. The spread between the bank
bill swap rate and the expected policy rate (OIS) has risen in recent days but remains low, nothing at
all like what occurred in GFC.
Exchange rate volatility has been very low for a considerable period of time, but has picked up in the
past few days. However it still remains considerably lower than volatility in other financial markets.
The yen has appreciated by as much as 10 per cent against the US dollar, as Japanese
investors repatriate funds, as normally occurs in these type of situations (Graph 9). More
surprisingly, the euro has also appreciated against the US dollar. Market intelligence indicates
that part of the reason for this is the liquidation of trades that were funded in euros and invested in
higher yielding assets such as emerging market bonds. The sharp narrowing in the interest differential
with the US has also contributed.
The Australian dollar has depreciated by 6 per cent since the beginning of the year to decade
lows against the US dollar and on a trade-weighted basis (Graph 10). This will provide a
helpful boost to the Australian economy and has occurred despite the prices of the bulk commodities,
iron ore and coal, remaining resilient.
Turning to monetary policy, the Board met last week and decided to lower the cash rate by 25 basis
points to 0.5 per cent. This decision was taken to support the economy by boosting demand and
to offset the tightening in financial conditions that otherwise was occurring.
The reduction in the cash rate at the March meeting was passed in full through to mortgage rates. The
cash rate has been reduced by 100 basis points since June. This has translated into a reduction in
mortgage rates of 95 basis points. This has occurred through the combination of a reduction in the
standard variable rate of 85 basis points, larger discounts to new borrowers and existing borrowers
refinancing to take advantage of larger discounts. While a lower and flatter interest rate structure
puts pressure on bank margins, it is important to remember that the easing in monetary policy will help
support the Australian economy which in turn supports the credit quality of the banks’ portfolios
of loans.
The virus is a shock to both demand and supply. Monetary policy does not have an effect on the supply
side, but can work to ensure demand is stronger than it otherwise would be. Lower interest rates will
provide more disposable income to the household sector and those businesses with debt. They may not
spend it straight away, but it brings forward the day when they will be comfortable with their balance
sheets and resume a normal pattern of spending. Monetary policy also works through the exchange rate
which will help mitigate the effect of the virus’ impact on external demand.
The effect of the virus will come to an end at some point. Once we get beyond the effect of the virus,
the Australian economy will be supported by the low level of interest rates, the lower exchange rate, a
pick-up in mining investment, sustained spending on infrastructure and an expected recovery in
residential construction.
The Government has announced its intention to support jobs, incomes, small business and investment
which will provide welcome support to the economy. The combined effect of fiscal and monetary policy
will help us navigate a difficult period for the Australian economy. They will also help ensure the
Australian economy is well placed to bounce back quickly once the virus is contained.
At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.50 per cent. The Board took this decision to support the economy as it responds to the global coronavirus outbreak.
We suspect some banks will have difficulty in passing that cut through to mortgage holders, given the lower bounds problem. Westpac has however as first mover.
And the RBA only has one shot in the locker before QE starts.
The coronavirus has clouded the near-term outlook for the global economy and means that global growth
in the first half of 2020 will be lower than earlier expected. Prior to the outbreak, there were signs
that the slowdown in the global economy that started in 2018 was coming to an end. It is too early to
tell how persistent the effects of the coronavirus will be and at what point the global economy will
return to an improving path. Policy measures have been announced in several countries, including China,
which will help support growth. Inflation remains low almost everywhere and unemployment rates are at
multi-decade lows in many countries.
Long-term government bond yields have fallen to record lows in many countries, including Australia. The
Australian dollar has also depreciated further recently and is at its lowest level for many years. In
most economies, including the United States, there is an expectation of further monetary stimulus over
coming months. Financial markets have been volatile as market participants assess the risks associated
with the coronavirus. Australia’s financial markets are operating effectively and the Bank will
ensure that the Australian financial system has sufficient liquidity.
The coronavirus outbreak overseas is having a significant effect on the Australian economy at present,
particularly in the education and travel sectors. The uncertainty that it is creating is also likely to
affect domestic spending. As a result, GDP growth in the March quarter is likely to be noticeably weaker
than earlier expected. Given the evolving situation, it is difficult to predict how large and
long-lasting the effect will be. Once the coronavirus is contained, the Australian economy is expected
to return to an improving trend. This outlook is supported by the low level of interest rates, high
levels of spending on infrastructure, the lower exchange rate, a positive outlook for the resources
sector and expected recoveries in residential construction and household consumption. The Australian
Government has also indicated that it will assist areas of the economy most affected by the
coronavirus.
The unemployment rate increased in January to 5.3 per cent and has been around
5¼ per cent since April last year. Wages growth remains subdued and is not expected to
pick up for some time. A gradual lift in wages growth would be a welcome development and is needed for
inflation to be sustainably within the 2–3 per cent target range.
There are further signs of a pick-up in established housing markets, with prices rising in most
markets, in some cases quite strongly. Mortgage loan commitments have also picked up, although demand
for credit by investors remains subdued. Mortgage rates are at record lows and there is strong
competition for borrowers of high credit quality. Credit conditions for small and medium-sized
businesses remain tight.
The global outbreak of the coronavirus is expected to delay progress in Australia towards full
employment and the inflation target. The Board therefore judged that it was appropriate to ease monetary
policy further to provide additional support to employment and economic activity. It will continue to
monitor developments closely and to assess the implications of the coronavirus for the economy. The
Board is prepared to ease monetary policy further to support the Australian
The latest data from the RBA, the credit aggregates to end January 2020 were released today. Total credit grew by 0.3% last month, compared with 0.2% in December. This gives an annual rate of 2.5%, compared to 4.2% in January 2019.
The annual series shows that owner occupied housing rose 5.1%, investment housing lending is down 0.3% and overall housing at 3.1%, up from a low of 3% in November, so hardly stellar.
Business credit rose by 0.5% in January, compared with 0.2% in December, giving an annual rise of 2.8% compared with 5% a year ago. That was the biggest mover.
The monthly series are always noisy, and the RBA seasonally adjusts the results without explanation, so we have to take their word for the results.
The 3 month rolling series shows a small uptick in investment lending to zero percent, while owner occupied lending was up to 1.4%, so weak growth only. Business was a little stronger, and personal credit fell at a slower rate of minus 1.5%.
The broader credit and money supply metrics showed that over the past year total credit rose at 2.5%, slightly higher than last month, while broad money fell a little to 4.2%
Overall the credit weakness continues to bite. We will see what the new loan data tells us when its released in a couple of weeks, as the net weak numbers could be masked by larger repayments from households seeking to deleverage in these uncertain times.
Finally 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, and growth rates should not be calculated from data on the levels of credit. 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.
Since the July 2019 release, the financial aggregates have incorporated an improved conceptual framework and a new data collection. This is referred to as the Economic and Financial Statistics (EFS) collection. For more information, see Updates to Australia’s Financial Aggregates and the July 2019 Financial Aggregates.