Tag Archives: central bank

Why the gloomsayers are overdoing it

When national leaders talk up how good things are, it is often taken as a sign that they are about to turn very bad.

So when Barack Obama and Malcolm Turnbull each delivered upbeat speeches in the past week, more than a few pessimists probably took them as vindication of their bleak outlook.

After all, there seems to be plenty to be worried about.

The new year has begun in a flood a red ink on global sharemarkets as China growth fears, weak commodity prices, terrorist attacks and natural disasters have all weighed heavily on investor sentiment.

For those determined in their gloom, the latest update on the Chinese economy suggested additional reason for pessimism. The world’s second largest economy expanded at an annual rate of 6.9 per cent in the last three months of 2015, its the slowest pace in 25 years.

Taken together with the decision by the International Monetary Fund to trim its global growth forecasts for 2016 and 2017 by 0.2 of a percentage point each to 3.4 per cent 3.6 per cent respectively, and the bearish mood would seem to be well founded.

But in striking discordantly upbeat messages about the outlook, Messers Obama and Turnbull are not just handing around warm cups of cocoa.

There are concrete reasons to think the gloom is overblown.

Although a sudden upsurge in economic activity appears as likely as a return by Tony Abbott to the Lodge, there are several pointers – local and international – that suggest optimism is not misplaced.

Most importantly, the US economy – still overwhelmingly the largest in the world – appears well established on a growth path.

If the US Federal Reserve’s much-anticipated interest rate increase late last year did not confirm it, a streak of sustained jobs growth that has seen the unemployment rate halve from 10 to 5 per cent ought to allay doubts.

Yes, many jobs have been part-time or casual, and wage growth is weak. And there are headwinds from the weak oil price, which has kicked the stuffing out of the shale gas industry, and the increasing US dollar, which will weigh on export competitiveness.

But cheaper petrol has also boosted real household income, and the American consumer is back shopping and spending, which in turn is encouraging businesses to hire and invest.

As has been widely recognised for some time now, China is engaged is engaged in a highly challenging phase in its economic and political development.

The investment-led growth model that has powered its expansion for the last 25 years has run its course, and left a massive overhang of excess capacity and troubling debt.

If this was not challenge enough, the central government’s reluctance to loosen its control over the economy is coming back to bite it. As The Economist notes, its current situation of a slowing economy, a semi-fixed currency and increasingly porous capital controls is a volatile combination – if the government loosens monetary policy to boost consumption, it will weaken the currency and encourage even more capital to flow offshore.

Still, the Chinese government has plenty of ammunition if recession threatens – $US3 trillion of foreign exchange reserves and ample room to trim interest rates and devalue the yen.

The gloom about Australia’s prospects is also overstated.

The fall in commodity prices has been steep, but so was their rise. As Rod Sims recently pointed out in The Australian Financial Review, the current dominant market narrative of a “collapse” in commodity prices is underpinned by a short-term view. From a historical perspective, they are more accurately depicted as returning toward their long-term average.

Pessimists also point to soft wages growth and a weakening housing market as causes for concern.

But the country is generating sufficient jobs to edge the unemployment rate lower – it fell to 5.8 per cent in December – setting a firmer base under pay rates and raising the prospect of an eventual consumption-boosting lift in household incomes as spare capacity shrinks.

And although capital gains in housing have slowed as some of the heat has gone out of the property market, sentiment toward buying shows signs of picking up.

On the question of whether now was a good time to buy a dwelling, the Westpac-Melbourne Institute Consumer Sentiment Index found a sharp improvement in mood. The index jumped almost 14 per cent this month to 113 points – the highest reading since May last year and only a little below the level of a year ago.

Westpac chief economist Bill Evans says the reading should be treated with some caution, but nevertheless “ma be signalling some improving optimism in the housing market”.

This interpretation is supported by a jump in house price expectations following a plunge in the second half of 2015.

Late last year, Reserve Bank of Australia Governor Glenn Stevens estimated the economy was “roughly half way” through the decline of resources investment, and a rebalancing in the sources of growth was underway – a process that will be greatly aided by the falling currency.

Economic commentary often exudes an unjustified air of certainty.

But the sharemarket’s current bloodletting, but a focus on this has tended to blot out some of the more positive big picture developments occurring.

This is one of those seemingly rare occasions when it may pay to heed the message of political leaders.

 

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The case for regulation

Taking unfashionable positions seems to be part of the job description for central bankers.
And the Reserve Bank of Australia was at it again yesterday.
The Abbott Government has been trying to endear itself to the business community by talking up its campaign to slash red tape, headlined by its so-called Repeal Day on March 26, when 10,000 pieces of legislation and regulation were put on the chopping block.
Few would quibble with the move to get the Dried Fruits Export Charges Act 1927, which set a levy of one-eighth of a penny for each pound of dried fruits exported, off the books.
But, as the RBA pointed out in its submission to Financial System Inquiry, the mania to be rid of regulation must have its limits.
Reflecting on the nation’s ability to endure the global financial crisis in much better shape than most other major developed economies, the Reserve Bank said Australia’s “sound prudential framework” had served it well, and saw no need for major change to current arrangements.
Many in the finance sector chafe under what they see as the unfair regulatory burden and capital requirements placed on Australian banks in complying with the terms of the international Basel III rules.
The rules were developed to help reduce the vulnerability of the global financial system to future credit shocks, including by increasing capital adequacy requirements for banks.
While the RBA and APRA are among those who successfully argued for some leeway in applying the new standards to take account of different business models and operating environments, Australian banks have nonetheless – like their overseas counterparts – had to increase the amount of capital on hand to help offset liabilities.
Often, regulation is seen as a dead-weight cost without any perceptible redeeming benefit.
In this it is like investing in education with the aim of boosting national productivity – the upfront cost is all-too apparent, while the pay-off is distant and rather nebulous: you know that a better educated and higher skilled workforce will be more productive, but credibly quantifying the effect is difficult.
That is why there was some benefit out of the gloom caused by the GFC. As the RBA said in its submission, it showed “that the costs imposed by effective regulation and supervision are more than outweighed by the costs of financial instability, even if that differential only usually becomes apparent after prolonged periods”.
That is, financial crises only happen every now and then, but when they do, the insurance of a robust financial system is worth the regular but relatively small cost of regulation.
In keeping with this “nothing good comes for free” theme, the RBA also backs the idea that the banks be charged a fee for the protection to depositors provided under the Financial Claims Scheme.
One of the key lessons the central bank draws from the GFC is that “the financial cycle is still with us”, meaning that risks have to be managed.
In its submission to the inquiry, the RBA made a number of other noteworthy observations and recommendations.
While much attention in recent years has been on competition in the mortgage market, the central bank said competition in small business lending was much weaker and deserved greater attention.
It also warned politicians off the idea of forcing superannuation funds to invest in certain sectors or asset classes, and questioned whether or not the fees and costs charged in managing retirement savings were reasonable.

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Timely warning for home buyers

As fears for the stability of the global financial system continue to ease, the thoughts of a central bank inevitably turn to more home grown concerns.
So it is that the Reserve Bank of Australia has issued a timely reminder to homebuyers that interest rates will not remain at record lows indefinitely.
In its biannual stocktake on the health of the local and international financial system, the Financial Stability Review, the RBA has devoted some attention to developments in the local property market.
This is hardly surprising – as the US sub-prime crisis so spectacularly demonstrated, what goes on in real estate can have explosive and devastating consequences for the rest of the economy.
Low interest rates are usually seen as a good thing (except by those trying to live off interest-bearing investments), but they come with risks.
The longer that rates stay low, the more desperate the competition among lenders for customers, and the greater the temptation for borrowers to increase their debt.
While rates stay low, many borrowers may be comfortable servicing their loan. But, inevitably, rates will rise, and as the financial squeeze increases, an increasing proportion of borrowers may find themselves in over their heads. And if they can’t unload their assets at a price to cover their debt (as can occur when many people simultaneously find themselves in trouble) things can get ugly very quickly.
This is the scenario the RBA is keen to avoid, and explains why it is watching borrowing behaviour and lending practices like a hawk.
It warned in today Review that there are already “indications that some lenders are using less conservative serviceability assessments when determining the amount they will lend to selected borrowers”.
It goes on: “It is important for both investor and owner-occupiers to understand that a cyclical upswing in housing prices when interest rates are low cannot continue indefinitely, and they should therefore account for this in their purchasing decisions.”
In other words, don’t bank on the idea that the recent surge in house prices will be sustained. If you are borrowing to your limit to buy a house, don’t be surprised when interest rates eventually go up, and the price you paid turns out to be at the top of the market.
None of these dangers are in immediate prospect.
The international economic recovery is still in its early days, and subdued local growth means there is little pressure at this stage to inch official interest rates higher.
But, while financial markets don’t expect the RBA to begin tightening monetary policy until at least early next year, the RBA might be tempted to act sooner if it sees a risky build up in household debt.

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Highest unemployment rate in 11 years doesn’t equal interest rate cut

A lift in the unemployment rate to 6 per cent – its highest point in almost 11 years – will surprise no-one.
In fact, the real surprise has probably been that it has taken this long.
In keeping with the trend of previous jobs reports, the Australian Bureau of Statistics has revealed that a further decline in full-time employment occurred in January, this time by 7100 positions, taking the number of Australians employed full-time to 7.95 million – the lowest number in almost two years.
The reason the unemployment rate has jumped to 6 per cent after spending the latter half of 2013 stubbornly stuck around 5.7 and 5.8 per cent is because, perversely, because the number of discouraged job seekers has stabilised.
The participation rate, the proportion of the working age population in the labour force (ie with a job or actively seeking employment), held steady last month at 64.5 per cent.
Amid all the high-profile announcements about factory closures (most notably and immediately, the SPC cannery in Shepparton), few people will be shocked by confirmation that the unemployment rate has increased.
The number of Australians who want to work but haven’t got a job now stands at 728,600 – a jump of almost 17,000 from last December.
But does this mean the Reserve Bank of Australia will put a rate cut back on its agenda?
That appears unlikely.
The central bank had anticipated that the unemployment rate would at some point reach above 6 per cent, so the fact that it has now done so will not be “new news”.
Additionally, inflation has turned out to be stronger than the RBA had anticipated, making it wary about adding further stimulus to the economy.
As noted in a previous post, RBA Governor Glenn Stevens was unusually explicit following the central bank’s February 4 Board meeting about the future course of interest rates.
Usually, like many central banks, the RBA shies away from being too definitive about the future of monetary policy, which is not unreasonable given the fluidity of global economic and financial conditions.
So when Mr Stevens said the most prudent course for the RBA was “a period of stability in interest rates”, it was a clear message to markets not to expect rate cuts – or hikes – any time soon.
An unemployment rate with a ‘6’ in front of it would not appear to change that message.

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RBA locks in 2.5 per cent cash rate – for now

Don’t expect interest rates to go up any time soon but, equally, don’t expect them to go down – that was the clear message from the Reserve Bank today.
In unusually direct language, RBA Governor Glenn Stevens has moved to lay to rest interest rate speculation for the next few months, saying the most prudent course for the central bank to take was likely to be “a period of stability in interest rates”.
That is central bank speak for everyone – those predicting imminent rate rises, and those calling for rate cuts – to take a Bex and calm down.
As mortgage holders ponder the pros and cons of fixing part of their loan, and investors do their credit sums, the Reserve Bank has tried to give some reassurance by flagging official rates are not likely to move for some time yet.
As widely tipped, the RBA has decided to hold the official cash rate at 2.5 per cent this month.
What many may not have anticipated though, was the central bank’s unusual willingness to flag its interest rate intentions.
Following the Reserve Bank Board’s first meeting for 2014, Mr Stevens released a statement that showed the RBA is in no rush to change its policy settings.
“On present indications, the most prudent course is likely to be a period of stability in interest rates,” he said.
The Reserve Bank sees no compelling reasons yet for either a rate increase, or a rate cut.
Unexpectedly strong inflation growth in the December quarter (underlying inflation grew by 0.9 per cent to be up 2.6 per cent from a year earlier), along with the falling exchange rate and increased housing activity, had prompted some to speculate that the RBA would soon have to consider raising the c ash rate.
But while Governor Stevens admitted monetary policy was “accommodative”, interest rates were “very low”, and house prices have surged, there was as no yet sign of a dangerous build up in indebtedness. In fact, household credit growth is moderate.
On inflation, the central bank so far does not seem to be phased by the jump in prices in December, some of which it attributed to importers and retailers quickly passing through to consumers much of the increase in costs caused by the easing exchange rate.
Mr Stevens said that although inflation was stronger than the central bank had predicted when it released its most recent Statement on Monetary Policy late last year, it was “still consistent with the 2 to 3 per cent target over the next two years”.
Those arguing the case for a rate cut have pointed to the nation’s anaemic growth rate (2.3 per cent in the 12 months to the September quarter 2013), a plunge in mining investment and weak labour market (the economy shed almost 32,000 full-time jobs in December and the unemployment rate is expected to rise above its current 5.8 per cent) to show the need for more support for activity.
But to this line of argument, Mr Stevens said monetary policy was “appropriately configured” to foster growth in demand (ie don’t expect them to go any lower).
Of course, the RBA might be considering the possibility (raised by Deloitte Access Economics director Chris Richardson) that commercial banks will lower their lending rates as they secure cheaper sources of funding on international markets. The Governor’s statement gives no hint on this front, except to say that long-term interest rates and risk spreads remain low, and there is adequate funding available through credit and equity markets.
As the economy gropes toward sources of growth to replace the sugar hit from resources investment, conditions are likely to stay rocky and uncertain.
In this shifting economic environment the RBA has moved to provide consumers and investors with one welcome point of consistency, at least for the next few months.

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No more rate cuts, but no rush to tighten yet

Interest rates look set to head higher, but the RBA’s “considerable uncertainty” about the pace of recovery in much of the economy means the first rate hike of the cycle could be delayed until well into 2014.

In a widely-anticipated decision, the RBA Board has decided to hold the cash rate at 2.5 per cent – meaning it will have been at this historically low level for six months by the time of the Board’s next meeting on February 4.

There is clear evidence that low interest rates are having an effect.

The property market is strengthening (house prices have risen, building approvals are up 23 per cent from a year ago), company profits are growing (up almost 9 per cent in 12 months), shares are rising (up 20 per cent in the year to date), and retail sales are increasing at a sustained solid clip (three consecutive monthly increases of 0.5 per cent or greater).

And the central bank thinks there is more of such news to come.

As RBA Governor Glenn Stevens put it today, “The full effects of these decisions [to ease monetary policy] are still coming through, and will be for a while yet”.

This is coupled with tentative signs that activity in the non-mining parts of the economy is picking up.

Official capital expenditure data showed manufacturers and other businesses were gradually increasing their investment, and the latest report from credit reporting firm Dun & Bradstreet showed 10 per cent of firms intend to hire extra staff in the first quarter of 2014.

If this is accurate, and businesses act on their hiring intentions, the unemployment rate may not rise much higher.

In further promising news, the official GDP numbers for the September quarter, due out tomorrow, may also be a bit stronger than many have been predicting.

The Australian Bureau of Statistics threw in a surprise today with its report that the trade surplus surged more than 50 per cent in three months to almost $9 billion, adding around 0.7 of a percentage point to activity in the September quarter.

The RBA’s known unknowns: the dollar and non-mining activity

But the persistently strong dollar and the sputtering recovery in economic activity outside the mining sector are the two greatest areas of uncertainty for the Reserve Bank.

Continuing recent efforts to talk the currency down, Stevens said the dollar (which was trading at just below US91 cents following the RBA announcement) was “still uncomfortably high”.

He almost didn’t need to add that the high exchange rate will have to come down in order for the economy to achieve “balanced” growth.

On this front, the Governor admitted that expectations for an acceleration in activity outside the mining sector were subject to “considerable uncertainty”.

Market Economics managing director Stephen Koukoulas is one of the few who for some time now have been predicting rates to rise in 2014 – he tips in the first three months of next year.

But the strong dollar could make it hesitate.

Koukoulas, for one, thinks there is much more the RBA needs to do much more to get the currency down – jawboning alone has had little effect.

If he is right, look for big sell-offs of the currency in coming days.

 

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A good week for the RBA

Every now and then you have a week when things seem to go right – your baby son suddenly begins sleeping soundly and copiously, you get the perfect park at work – twice! – and your bank gets in touch to say it has made a $100 mistake in your favour, and lets you keep it (ok, so that last one never happens, it is just a dream).

The Reserve Bank of Australia has just had such a week.

When the RBA Board sits down tomorrow for its monthly monetary policy meeting, it will see little reason to move the official cash rate.

All the signs are that the economy is behaving in ways that it has anticipated, and that are broadly in keeping with its monetary policy stance.

Low interest rates appear to be working to encourage activity in non-mining parts of the economy, particularly housing, while the dollar is depreciating and worrying price pressures are yet to appear.

Though there was a slip in building approvals last month (down 1.8 per cent), much of this was due to the volatile apartments segment of the market, and annual growth remains a healthy 23.1 per cent.

Of course, holding interest rates at historically low levels for an extended period carries with it risk, and some have started to fret that a bubble in the housing market, particularly in Sydney, is developing.

But the overblown talk of an over-heating property market, never well-founded, looks increasingly silly. Sure, house prices have surged in the major cities – most notably Sydney and Melbourne – but there are at least three good reasons to dismiss talk of a bubble at this stage. Firstly, there are signs that the market in established housing is losing some of its heat and price growth is easing. Secondly, and perhaps most importantly, credit growth remains modest – borrowing for housing grew by 0.5 per cent in each of September and October to be up 5 per cent from a year earlier, which is hardly what could be described as “bubble-like”. Thirdly, the nation’s population is growing at a solid rate of around 1.8 per cent, and the easing dollar makes Australian property an increasingly attractive proposition for foreign investors.

There are also encouraging signs that manufacturers and other businesses are starting to pick up the pace of their investment – a development that is coming none too soon, given the rapid deceleration in mining investment.

Official figures show that in the September quarter, mining companies cut their spending on plant and equipment by 7.1 per cent (while expenditure on buildings and structures increased 5.6 per cent). In the same period, manufacturers spent an extra 3 per cent on plant and equipment, and increased funds for buildings by 1.5 per cent.

Any investment plans should be well supported by healthy balance sheets. The Australian Bureau of Statistics confirmed today that business profits grew almost 4 per cent in the September quarter and are up almost 9 per cent in the past year. In the same period, wages have grown 3.1 per cent.

While GDP figures out on Wednesday are likely to show the economy was just ticking over in the September quarter, evidence that non-mining activity is building should push consideration of more rate cuts further into the background.

Instead, the RBA Board may soon begin to consider the timing of a rate hike.

Though it is unlikely to make such a move tomorrow, the central bank will be heartened by the dollar’s slide in recent days. Governor Glenn Stevens made it clear again last week that he thought its sustained strength against the greenback has been increasingly difficult to justify.

Inflation and wages appear well contained for now, but the longer the cash rate is kept at 2.5 per cent, the greater the risk prices could accelerate, which would in turn increase pressure for wage hikes.

As ever for a central bank, the trick is in the timing. Push up rates too soon or too fast, and the dollar could rebound, but leave them low for too long and potentially destabilising price pressures could accumulate.

 

 

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