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RBA Governor’s testimony: confirms home loan rates to rise, timing uncertain

Opening statement
The Governor concluded his statement with: “If economic conditions evolve roughly as we expect, further adjustments to monetary policy will probably be needed over time to ensure that inflation remains consistent with the target over the medium term”. This repeats the wording of the RBA’s statement from the February meeting. On world growth, the Governor notes that the pace over the second half of 2009 was 4% annualised and that is the pace expected in 2010 by forecasters. Global challenges for 2010: (1) A two-speed global recovery and (2) increasing focus on sovereign creditworthiness/fiscal consolidation. The RBA Governor highlighted that Australia is relatively well placed in both these areas.
The RBA’s growth forecasts for Australia were repeated: a bit over3% for 2010 and about 3½% in 2011 and 2012. Note was made of the mild downturn and the low peak in the unemployment rate and the implications of this. “It also means that there is less scope for robust demand growth without inflation starting to rise again down the track. Monetary policy must therefore be careful not to overstay a very expansionary setting.” On credit, the Bank also made a point of indicating that: “We have taken careful note also of non-price credit conditions.” For “some other business borrowers (ie non large firms), access to credit has remained difficult …. it is reasonable to expect that lenders will become more willing to lend over the coming year.”
One interpretation of this, and other comments, is that the RBA perceives a degree of caution in spending decisions by consumers and business, that housing credit growth is healthy but not rapid and that parts of the business sector are somewhat credit constrained. More generally, the subdued rate of credit growth economy-wide (sluggish even allowing for temporary balance sheet adjustment) casts some doubt over the pace at which recovery will be sustained domestically, and may have been one of the factors behind the February pause.

Questions & Answers
(1) How close are we to normal?
The RBA focuses on average borrowing rates when considering the stance of policy. The RBA judges that rates are still 50bps to 100bps below the decade average or below normal. Rates are no longer in
the emergency zone.
(2) Why did the RBA pause in February?
The RBA emphasised that one of the benefits of beginning the tightening cycle early is to have the luxury to assess the impact of initial moves. The RBA did just that in February, deciding they wanted to assess the impact of the first three moves and of the additional adjustment by commercial banks. The Governor also noted that the RBA’s interpretation of some domestic data released early this year differed from that of the markets. Unfortunately, the Governor did not elaborate or identify the data in question.
(3) Greece debt issue
The RBA Governor was balanced on the Greece issue. He saw the potential for turmoil to impact global growth. When pressed, he saw Greece’s debt problems – at the margin – as a consideration for leaving interest rates on hold at the February meeting (domestic factors were central). The RBA does not expect these issues to directly impact upon Australia’s sovereign debt position – Australia’s
position is far more favourable. While the comments were balanced, we're mindful that RBA thinking could shift prior to the March meeting if events unfold quickly.

4) Regulatory changes for the financial system

The RBA recognises that regulatory changes pose a medium term constraint to Australia's growth. Requirements will be for higher liquidity, thereby imposing higher funding costs and implying that credit will be less freely available. The Governor stressed that regulatory changes aim to enhance the resilience of the financial system to the next crisis but must not impair our ability to recover from this one. He was confident that an adequate solution, from an Australian perspective, will be found.

(5) Inflation target

There was strong opposition to relaxing the inflation target to 4%, as suggested in a recent IMF paper. The RBA argued that Australia's flexible inflation target approach was a success, enabling the RBA to respond to emerging imbalances. The 2003 period, when the housing market became overheated, was cited.
(6) Housing bubble
In assessing the existence of a housing bubble, the Bank considers the pace of credit growth and lending standards, as well as prices. This framework suggests that a bubble does not exist at present. Housing credit growth was described as healthy but not rapid. While lending standards are not falling but rising. A concern may arise if prices were to continue rising at the current pace. However, there is already evidence that prices have recently levelled out at the bottom end of the market – in the wake of higher interest rates and a winding back of first home buyer grants. At the top end, price rises represent a bounce back after a significant reaction to the downturn. More generally, in terms of asset bubbles, it is the degree of leverage that is the critical concern.
(7) Labour market strength
The RBA believes that the unemployment rate is unlikely to fall much in the next half year. Rather, they expect average hours worked to rise. We would note, however, that this has not been the case in recent months. We would also highlight that policy needs to be set with a 12 to 18 month outlook – in which time the unemployment rate (which is currently a relatively low 5.3%) is likely to be falling below 5%.
(8) Consumer spending behaviour Consumer spending is not expected to be the same driver of growth over the next five years as it was over the last decade. Rather, the resource sector will be leading the way. The thinking is that households, adjusting to the recent experience, are less willing to take on debt. We expect this thesis to be put to the test in the next year, with housing construction activity in a strong upswing – which typically triggers a marked acceleration in consumer spending on household goods. Our view: We continue to expect a March rate rise and still see this as a 50-50 call. While the precise monthly timing of rate moves is uncertain, we are confident the cash rate will increase to 4.5% in 2010. The outlook for the Australian economy is upbeat and this economic upswing begins with considerably less spare capacity than normal.

Andrew Hanlan, Senior Economist