The Reserve Bank Board meets on March 7.
We can be certain that the decision from the Board will be to hold rates steady.
Recall the comments from the Governor in his answer to a question during his appearance before the House of Representatives Standing Committee on Economics, “At the moment the market pricing is for interest rates to be constant right through this year. That seems a reasonable proposition to me…. The central scenario of a period of stability of interest rates is quite reasonable to me.”
Now we have never framed our medium term forecasts around the views of the Reserve Bank – after all they are only “mortal” forecasters like the rest of us . Their forecasts can go awry and policy can change accordingly. But for the immediate future ( like next week) we can take the Governor’s views as definitive.
Our view since the rate cut in May last year has always been for a follow up move in August and the steady rates throughout the remainder of 2016 , 2017 and 2018.
We assess that at least the Governor currently has that view for 2017 but has not commented on the market implied two rate hikes in 2018.
His growth forecast in 2018 is 2.75 percent-3.75 percent (down from 3-4 percent) well above our forecast of around 2.5% (with downside risks). Achieving the RBA’s growth forecast in 2018 might be consistent with market pricing but, certainly, our forecast for a slowdown in 2018 is not consistent with rate hikes – below trend growth signals steady rates at best.
In his comments to the House the Governor considers the case for rate cuts in 2017. He points out that inflation is below the target range ( “a bit low”) and the unemployment rate is “a bit high”. We would assess full employment at around 5% so, at 5.8%, there is clear excess capacity in the labour market. Of course, that spare capacity is further emphasised in the latest wages report which showed wages growth at a record low of 1.8 percent.
However, his clear problem with leaning further on interest rates is “The main effect (of a rate cut) would be more borrowing for housing, pushing up house prices…”.
His concerns with the impact of rate cuts on the housing market are well based.
Consider figures 1 and 2.
Figure 1 shows recent trends in house prices in Australia. The recent periods of rate cuts (first half of 2015 – February and May) and second half of 2016 (rate cuts in May and August) are associated with significant increases in house price inflation. However, note the trends in the intervening period. These will not be lost on the Governor.
During the period (second half of 2015) when the Bank and APRA imposed macro prudential guidelines to slow the pace of lending to investors the pace of house price inflation (national) slowed from 13.7% (six month annualised to August 2015) to zero (6 month annualised to March 2016). In response to the May and August rate cuts house price inflation has lifted to 10% (6 month annualised to February 2017).
Figure 2 shows a similar trend for new lending for housing (key to Governor’s concerns about rate cuts just boosting household debt). In response to the rate cuts in 2015 new lending for housing peaked at $26.8 billion in August 2015 . It subsequently slowed to $23.8 billion by January 2016 (down 11%) only to pick up to $27.1 billion (up 14%) by December 2016 in response to the May and August rate cuts.
The conclusion that the Bank would have reached is that macro prudential policies do work and rate cuts stimulate prices and credit despite rates being so low.
Little wonder that the Governor noted at the Hearing when referring to recent macro prudential policies, “For us, that is a first order thing that we can do to limit the growth rate of investor credit and, I think, that has been a successful public policy intervention.”
I assess that, given that both Sydney and Melbourne prices are up 14% (six month annualised – Core Logic data) the Bank and APRA may be considering even tighter macro prudential policies.
It is not only inflation and the unemployment rate that would be of concern to the Reserve Bank.
Throughout the Hearing he indicated a preference for a lower Australian dollar. He accepts that the AUD is probably around fair value but questioned the feed-back to activity from higher commodity prices with miners apparently reluctant to increase capacity and wage pressures in the sector continuing to ease.
He has also adopted a more conservative attitude to the consumer, expecting that the recent falls in the savings rate are unlikely to be sustained.
Most of this “mood” does not sit well with the expectation that growth will lift in 2018, particularly in the face of a downturn in residential construction. His “faith” that non mining investment will lift to reflect tightening capacity utilisation is not convincing particularly with the higher AUD and a more cautious consumer.
Overall we saw little in the comments at the Hearing to sway our expectation of a slowing economy in 2018. If, as we expect, the Bank will get around to adopting additional macro prudential policies to slow housing in the second half of 2017 the stage will be set for another year of steady rates in 2018.
With the economy slowing and macro prudential policies further tightening housing markets, the risks to rates in 2018 will be to the downside rather the upside as currently expected by markets.
BILL EVANS is chief economist of Westpac.
This article originally appeared in Property Observer.