RBA Testimony – Rates solidly on hold

Semi-annual testimony

• The Reserve Bank Governor has delivered the clearest message yet that interest rates are on hold for some time. The tone and comments from the testimony is consistent with CommSec’s view that the cash
  rate will remain on hold until at least mid-year and possibly even longer.
• “I’m fairly content with where we are at the moment, We are in a good position. We are ahead of the game which is where you want to be and that’s the thing that affords you periods of sitting, waiting and watching and sometimes they can be reasonably lengthy periods of time.”
• The key focus for the Reserve Bank is massaging the domestic economy through the unprecedented terms of trade boost that is currently taking place. The Governor admitted that “it is a difficult environment for retailers. But not entirely unwelcome in the current circumstances” given it would be harder to avoid the economy overheating if all sectors of the economy were firing.
• The Governor anticipated that the impact of the floods and cyclone will result in the inflation rate rising to “around 3 per cent in the June quarter”. However “These effects should begin to reverse in the second half of the year and should have largely dissipated by the end of 2011.”

What does it all mean?

• The Reserve Bank Governor has delivered his clearest statement yet that interest rates are on hold at least until mid year and possibly even longer. There wasn’t anything that was overly new in the Reserve Bank Governor’s commentary compared with what was released last week’s Monetary Policy Statement. Rather his comments today provided more clarity and reinforced our view that interest rates are solidly on hold in the near term – especially given that over the medium term inflation is well contained. Financial markets are not pricing in a rate hike in the near term and interestingly the Reserve Bank Governor did point out that he is “not particularly seeking to dissuade people from that view.”
• The clear sense from today’s testimony to the Parliamentary Economics Committee is that Reserve Bank officials are extremely comfortable with current settings. Interest rate settings are tighter than normal, but about right for the times. Prices may go up as a result of the floods, but the Reserve Bank thinks this will just be temporary. And while unemployment is low, the perception is that businesses aren’t finding it overly difficult to find workers at present.
• In the jargon, the Reserve Bank Governor has delivered an extremely “dovish” testimony – that is, Governor Stevens has ruled out interest rate hikes, saying that he is “fairly content with where we are at the moment.”
• The Reserve Bank remains quietly confident that the Australian economy is on a sustainable recovery path but the key is ensuring that growth remains robust while keeping inflation remains in check. The focus for the central bank is clearly the “once in a century” boost to the terms of trade – largely driven by higher iron ore and coal prices – and the resulting impact on the economy. In fact it may just be that the Reserve Bank has underestimated the increase in Australia’s terms of trade, with the Governor saying that:“it is higher than assumed three months ago and look like they will peak higher and later than we had previously assumed.”
• There is certainly no perception that the Reserve Bank maintains either an overly optimistic or overly pessimistic view. The Reserve Bank officials basically believe that they have settings right to handle future challenges – be it the impact of the floods, high terms of trade, tight job market or rising global commodity prices.
• While acknowledging that there has been a big change in household behaviour toward greater conservatism, RBA officials are unsure how long the trend will last for. Effectively people have been handed a huge fright from the global financial crisis and they are still adjusting. But while this makes it harder for retailers, from a broader economy-wide perspective it is not a bad thing that consumers are more conservative on spending and borrowing.

Key excerpts of the Reserve Bank officials’ testimony

Interest rate outlook

• “I’m fairly content with where we are at the moment, We are in a good position. We are ahead of the game which is where you want to be and that’s the thing that affords you periods of sitting, waiting and watching and sometimes they can be reasonably lengthy periods of time.”

Tightening of job market

• Stevens & Lowe both rejected suggestions that the labour market was tightening markedly. From RBA liaison, both indicated that mining firms were finding it more difficult to find staff but for businesses generally it was “not particularly hard to find workers at present”. Both said there isn’t the same sort of aggressive bidding for staff as there was back in 2007.

Inflation expectations

• The Reserve Bank Governor is confident that the floods-induced lift in fruit and vegetable prices shouldn’t lift inflationary expectations. The RBA will seek to ensure that people’s expectations of inflation don’t go up. Stevens: “I think we have a pretty good chance of doing it”.
• “It is worth recording that a combination, on the latest figures, of a 5 per cent unemployment rate and an inflation rate clearly ‘in the 2’s’ is a pretty favourable one by the standards of recent decades.”

Commodity Prices

• “Managing these pressures (rising commodity prices) is shaping up as one of the major international economic policy challenges of 2011.”

Terms of trade

• “Australia’s terms of trade are higher than assumed three months ago and look like they will peak higher and later than we had previously assumed.”
• …”we are experiencing a terms of trade event of very large size, of the type that happens only once or twice in a century. Our job is to try to manage this so as to avoid, as far as possible, the instability that has accompanied most previous such episodes.”

Cautious behaviour of households

• “This is quite a difficult environment for retailers. But from a macroeconomic point of view, perhaps it is, on balance, not entirely unwelcome in the current circumstances. If consumption were to boom at the same time as we try to expand the resources sector, upgrade urban infrastructure and increase our pace of housing construction to house a growing population, it would be harder to avoid the economy overheating.”
• “The simple story is that households have had a terrible fright. They have learnt – guess what – housing prices can fall and that having a lot of debt can be dangerous and that not saving anything out of your current income on the assumption that asset values going up is going to take care of your saving for you is possibly not a sustainable strategy and so they are changing behaviour, seeking to get debt down and so on and save more.”

Impact of floods and Cyclone Yasi

• “The result of this is likely to be a temporary rise in the CPI inflation rate, to around 3 per cent in the June quarter. This is higher than the figure in the Statement because the impact of Cyclone Yasi could not be included in that forecast. The combined contributions to this outcome of all the summer flooding and the cyclone add up to about half a percentage point or a little more. These effects should begin to reverse in the second half of the year and should have largely dissipated by the end of 2011.”

Medium-term outlook

• “Assessment of medium term outlook wouldn’t be overly different than what was discussed at the Board meeting.”

Inflation & unemployment

• “It is worth recording that a combination, on the latest figures, of a 5 per cent unemployment rate and an inflation rate clearly ‘in the 2’s’ is a pretty favourable one by the standards of recent decades.”

Monetary Policy Outlook

• “So, overall, financial conditions are on the firm side. In view of the general outlook that I sketched at the beginning, that seems to us to be appropriate. Having reached that position in a fairly timely fashion, the Board has judged it to be sensible of late to leave the cash rate steady.”
• Financial markets don’t assume a near-term rate hike: “I’m not particularly seeking to dissuade people from that view.
• “It’s about right for them (monetary policy settlings) to be where they are.”
• “ I think the current level (of cash rates) is about right for the medium-term”
• “The medium-term outlook is similar to last meeting.

State & Federal debt

• Stevens rejected suggestions that an increase in federal and state debt levels was complicating monetary policy decisions.
• “The question really is the availability of real productive resources to do the work.”
• Stevens rejected suggestions that Australian interest rates were too high – historically or globally.
• “The presumption that lower interest rates is always better I don’t think is right.”
• Stevens noted that our rates were “about normal” while rates in other advanced economies were still much lower than normal.

Wages

• On wages, Stevens noted that 3.5 per cent annual wage growth “is not inflation break-out territory”. “If it stays there I don’t think we have a problem with overall price pressures.”
• Stevens notes that the RBA expects the unemployment rate to ease over the next couple of years and that is expected to see wages lift modestly as well as underlying inflation.”

Tightness of policy

• Stevens says that the financing costs faced by borrowers including interest rates, charges and margins are “slightly higher than the 15-year average”. Stevens estimates that the estimate of “slightly higher” is around 50 basis points

Bank rates & margins

• Both Stevens & Battellino have rejected suggestions that bank competition has been insufficient to keep down rates and margins.
• Stevens: “There’s a lot of competition in the banking space it’s in the area of raising money in deposits and so on.”
• Battellino: “The key point is that the net interest margins of banks hasn’t really changed in the past five or six years.”
• “The return on equity of banks is actually lower than what it was a few years back.

November rate hike

• “I think it was the right call.”