Chris Caton: why a stay on interest rates adds up
Written and accurate as at: Nov 23, 2015 Current Stats & Facts
Chris Caton: why a stay on interest rates add up
4/11/2015
By Chris Caton Chief Economist, BT Financial Group
This week, the Reserve Bank of Australia (RBA) held interest rates at 2%, surprising half of the market that priced in a 25 basis point cut. This decision makes sense when you look at the two most important pieces of economic data released in October. I’m of course referring to the economic measures that actually sit within the Bank’s mandate: the labour market and inflation. We’ll also look at a third measure – housing market activity – which falls a little out of scope but weighs on the bankers’ minds.
Importantly, the unemployment rate remained at 6.2% in September. It has oscillated in a very narrow range in the past year. Like the Duke of York’s men, the trend appears to be neither up nor down. This is important because my default mantra continues to be that until it is clear that unemployment has peaked there is always the chance of a further rate cut and, once it is clear that the rate has peaked, rates will be moved (slowly) upwards as the monetary cannon is reloaded.
The simplicity of this mantra was complicated during the month, however. First, the September quarter CPI result came in below expectations. In the past year, the CPI has increased by just 1.5%, with the more meaningful underlying measures just above 2%. Given that the RBA’s target range is 2-3% (on average, over the course of the cycle), one can make a case that inflation in Australia is “too low”, and hence is itself a reason to cut rates. I prefer the depiction that inflation is low enough that it is simply not a concern and doesn’t stand in the way of a rate cut.
There was another development during the month that has significantly increased the probability of a further cash rate cut in the near future. In my opinion, the central bank has been a reluctant cutter for some time, and of the view that the record-low cash rate should suffice. But, of course, borrowers don’t borrow at the cash rate. The decision by the major 4 banks to raise the variable mortgage rate, together with the possibility of more upward pressure as a result of the Government’s acceptance of the financial system enquiry (which advocated stronger banks and hence higher capital requirements), could mean that the “retail rate” is now higher than the RBA would like, in which case the probability of a rate cut increases.
On the other hand (well I am an economist), the RBA may be quite happy to have some of the (localised) heat taken out of the property market. In fact, in this week’s statement from RBA, Governor Glenn Stevens, said:
“Low interest rates are acting to support borrowing and spending. While the recent changes to some lending rates for housing will reduce this support slightly, overall conditions are still quite accommodative… with growth in lending to investors in the housing market easing slightly while that for owner-occupiers appears to be picking up. Supervisory measures are helping to contain risks that may arise from the housing market.”
While it is true that auction clearance rates have fallen, they remain above the level usually associated with significant price weakness (that said, feel sorry for the denizens of Perth, where house prices are down by more than 6% from early in the year).
The slowing in the rate of growth of credit to investors to a 2-year low of just 0.5% in September (it was 1.2% as recently as May) should not be taken as an indicator of a slowing in the market. It is, for example, no coincidence that the growth of credit to owner-occupiers has accelerated in the past two months, to the highest rates since early 2010. How are these two related? At the margin, some borrowers have the ability to classify themselves as either owner-occupiers or investors. In days gone by, they may have opted to be called investors; among other things they can then include more income in demonstrating their ability to service a loan. Now, they can borrow at a lower rate if they are classified as owner-occupiers. Further, financial institutions have been asked to limit growth in credit to investors. When both parties to a transaction have an incentive to classify differently than they did in the past, it’s not hard to guess what happens.
It should also be remembered that when the RBA Governor, Glenn Stevens, was asked in late July about the APRA-imposed capital requirements, he said,
“I would imagine it will result in some rise in mortgage rates from the major banks. It’s supposed to, that’s the point.”
It’s also pertinent to note that the minutes of the October RBA Board meeting suggest that the Board was not at all disposed to ease further at that time. It seemed too much of a mind change to get from there, to a Cup Day cut.
For now, I see a continuation of an “on hold” bias from the bankers. I will be looking for any change in rhetoric from the RBA in the more comprehensive Statement on Monetary Policy to be released on 6 November, and watching closely the labour-market data releases in the next few months.
The views expressed in this article are the author’s alone. They should not be otherwise attributed. These views are current as at the date of production and can change day to day. This is general investment information and does not take into account your objectives, financial situation or needs. Before acting on the information or advice, you should consider the appropriateness of the information or advice in relation to your objectives, financial situation or needs.