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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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.
If, like me, in the last couple of days you’ve had a call from your bank eager to talk about how to they could save you money on your mortgage, you’ve probably twigged that something is up.
Usually they call to flog insurance policies I don’t want, or offer a lift in my credit card limit that I can’t afford.
So to hear them actually prepared to come to the table to strike a cheaper deal on what is one of their core products is an interesting development.
It tells me that their own economists have told them the prospects of an official interest rate rise sometime this year are looking pretty slim.
This is no news to the market, which sees no chance of a rate hike before March next year, and instead is pricing in the possibility of a rate cut.
As RBA Governor Glenn Stevens put it today when announcing the Reserve Bank Board had decided to hold the central bank’s cash rate steady for a seventh consecutive month, “on present indications, the most prudent course is likely to be a period of stability in interest rates”.
It also shows that the field of competition has well and truly shifted from deposits (remember when the interest rate on 3-month deposits reached above 5 per cent? It is now down to around 3 per cent), and the scramble now is to sign up home buyers.
It is pretty clear that at the moment the economy is like a dog on roller skates, desperately trying to gain some traction.
Mr Stevens said that, while consumer demand was “slightly firmer”, and data foreshadowed a “solid expansion” in housing (building approvals jumped 6.8 per cent in January to be up almost 36 per cent from a year earlier), demand for labour is weak and the unemployment rate is likely to rise higher.
Its cause isn’t helped by a Federal Government that at every opportunity thunders about the dire state of the nation’s public finances and hints darkly at the need for painful spending cuts.
In central bank-speak, “public spending is scheduled to be subdued”.
It can’t be doing anything to improve the willingness of businesses to invest. Official figures confirm private capital expenditure has been sliding for the past couple of years, even as profits have grown – gross operating profits were up 107 per cent in the year to the December quarter, yet over the same period private capex fell 5.7 per cent (and spending on plant and equipment plunged more than 16 per cent).
As Mr Stevens put it, resource sector investment is set to decline significantly, while there are only “tentative” signs of improvement in investment intentions in other sectors.
The economy is partly the victim of an unfortunate clash of timing between the business and political cycles.
The incentive for the Abbott Government is to cut hard in its first Budget, giving itself room for vote-enhancing largesse closer to the next election, while the economy could do with some productivity-enhancing infrastructure investment.
Fat hope of that at the moment.
Even more people are likely to be out of work in the coming months, and being able to negotiate a cheaper mortgage is likely to be of little comfort.
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.
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.
Though the loss of more than 31,000 full-time jobs in December 2013 has, not surprisingly, grabbed most attention, the Reserve Bank of Australia is possibly more interested in another set of numbers that came out today.
In a sign that low interest rates are having the desired effect, building activity is strengthening, improving 1.6 per cent in the September 2013 quarter to be up 5.4 per cent from a year earlier, according to the Australian Bureau of Statistics.
In the residential sector, new houses accounted for the majority of improvement – activity there was up more than 5 per cent from the September quarter 2012. This is on top of a significant 3 per cent upward revision in ABS estimates of dwelling commencements in the June 2013 quarter.
The improvement has also been reflected in measures of the value of all building work done, which rose above $21 billion in the September quarter for the first time in about two years.
The activity figures match RBA lending data, which show housing credit grew by 5 per cent in the year to last October.
Taken together, the results are adding to the pretty strong signal to the central bank that, notwithstanding December’s weak jobs numbers, it does not need to cut interest rates any further.
Before the release of the labour force data, markets had priced in a minor 7 per cent chance that the official cash rate would be lowered to 2.25 per cent at the RBA Board’s 4 February meeting.
Knee-jerk reaction might have pushed those odds a little higher since but it seems unlikely the unemployment reading will have unsettled the RBA, which anticipated the jobs market would soften through much of the coming year.
Instead, the on-going recovery in building work will have it pondering how much longer it should hold interest rates down at current levels.
Though inflation remains subdued, and talk of housing bubbles is (once again) exceedingly premature, household spending is clearly gathering some momentum. Retail sales are up, as are building approvals and home construction. Sure, job insecurity will be a not-insignificant handbrake on consumption.
But in the push and pull of economic forces, growth seems to be gaining ground, and the RBA is likely to view the 2.5 per cent cash rate as increasingly inappropriate.
The rate hike hares are running following evidence that shoppers are spending more freely and building approvals are back to levels last seen almost three years ago.
In a sign that the stimulus from low interest rates is sustaining an improvement in consumer outlook despite the soft employment market and federal budget gloom, retail sales rose 0.7 per cent in November to be up 4.6 per cent from a year earlier, while building approvals remained at their healthiest level in years, despite a small retreat from the previous two months.
The solid readings have led at least one prominent economist to predict the Reserve Bank of Australia will soon have to begin raising interest rates in order to ward off the risk of a surge in inflation.
Market Economics managing director Stephen Koukoulas said today the economy “is on fire”, and that the Reserve Bank Board should lift its cash rate when it returns for its first monetary policy meeting of the year on February 4.
The latest readings on the economy follow the release of figures last week showing the nation’s trade deficit narrowed significantly in the second half of 2013, a trend that is expected to continue as the completion of major resource infrastructure projects boosts the nation’s export capacity.
After reaching above $1.5 billion in mid-2013, the deficit had shrunk to little more than $110 million in November, and anecdotal evidence indicates there was strong growth in iron ore export volumes last month.
Adding to the picture, a Dun & Bradstreet survey released earlier this week indicated that business is becoming increasingly upbeat about its investment and employment intentions.
But worries about the health of the jobs market remain.
According to the Australian Bureau of Statistics, monthly job vacancies have been in a sustained decline since reaching a peak of almost 190,000 in early 2011. In November last year, the ABS reported, there were barely 140,000.
In its mid-year update on the economy, Treasury was downbeat on the labour market, predicting the jobless rate would rise to 6.25 per cent next financial year as the economy grew at below-trend rate.
But, as Kouloulas points out, the jobs market is a lagging indicator of economic activity, and the latest economic data suggest Treasury may have been too pessimistic.
For instance, between August and December it cut forecast dwelling investment growth from 5 to 3 per cent, though as it itself admitted, “finance commitments for new dwellings are now 12.4 per cent higher than a year ago and building approvals have improved noticeably from their trough in early 2012. Higher house prices could initiate a stronger investment response”.
The risk for the RBA is that, if it misreads the situation, a rate hike in the next month or so might puncture nascent optimism and slow or stall (at least temporarily) the recovery in non-mining sectors of the economy.
The risk is heightened by the Federal Government’s tub-thumping on the state of the Commonwealth Budget and looming threat of significant cuts in public sector spending.
In addition, raising rates could help reinflate the Australian dollar, something the RBA would be keen to avoid (one of this blog’s correspondents, @MrMacroMan, said that an RBA official speaking in New York overnight was “very clear on AUD risk and rates on hold”).
Yet, if analysts like Koukoulas are correct and the economy is taking off, an official interest rate of 2.5 per cent would obviously be inappropriate, and could sow the seeds of dangerous price pressures down the track.
As RBA Governor Glenn Stevens might say, the decision may come down to which is the path of last regret.
Fortunately for it, more evidence about the strength of activity is due to be released before the 4 February meeting, including finance and employment figures, as well as construction activity numbers.
In the meantime, markets are likely to be busily recalculating the odds of a rate move at next month’s meeting.
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.