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Be careful what you wish for on rate cuts

Today’s Reserve Bank board minutes show there’s an increasing gap between Canberra’s rhetoric and the RBA’s careful phrasing: the government’s budget surplus fixation won’t give the RBA "room to move should it choose to do so" but potentially force it to start stimulating the economy; banks aren’t “defying” the RBA and the Treasurer by raising rates but reflecting greater competition for funds.

If you’re one of the interest rate fixated, don’t worry about the latter business – the RBA targets the end rates people pay in setting monetary policy so the finetuning of the ANZ et al doesn’t really matter – but there are reasons to be very careful what you wish for when it comes to cutting rates.

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The minutes make clear the policy easing all but promised by the governor two weeks would come from a domestically-induced slowdown, not the wide world’s vicissitudes. And a key factor in that is “the likelihood of significant fiscal tightening in the next few years” – alias Canberra’s bi-partisan surplus craving.

The surplus-driven fiscal drag of around 2.5 per cent of GDP in the new financial year isn’t the only factor the RBA fears could drive inflation even lower than the mid-point of its target zone – the structural change and the soft housing sector also received specific mentions – but it’s the one where the RBA might be hinting at danger while the politicians are claiming high virtue.

The RBA minutes don’t talk in terms of Solly Lew’s profitability or Paul Howes membership number, but instead view the economy through the prism of the central bank’s primary responsibility: inflation. Thus the warning in this sentence:

“If slower growth in demand could be expected to result in a more moderate inflation outcome, then a case could be made for a further easing of monetary policy.”


That’s a “more moderate” inflation outcome than the RBA’s present forecast it staying very nicely in the middle of the 2-to-3 per cent target, meaning inflation being too low and the economy therefore needing stimulation.

This isn’t the surplus fixation story told by the federal Labor and Liberal Parties about “room to move”, about some absolute belief that reducing interest rates being an always desirable outcome: it’s a story that rates will be cut because the economy is underperforming.

Throwing the economic management load onto monetary policy because of political imperatives overtaking fiscal policy is poor government. Peter Costello did just that in the lead-up to the GFC, producing budgets with negligible or zero fiscal drag despite the surpluses, leaving the RBA to do the work of bashing the economy with escalating interest rates.

Now Swan and Hockey appear to be combining to do the opposite, leaving the RBA to do the work of lifting the economy back to trend growth by cutting interest rates. Both are examples of second-rate fiscal management. They could have been or be worse – third or fourth rate like most of the rest of the developed world – but neither is flash.

That’s the main game in today’s minutes, but there are some other interesting byplays. One is a subtle difference in the wording between the minutes and the governor’s brief statement after the board meeting a fortnight ago. Compare and contrast the minutes:

“The board would have the opportunity at its next meeting to review the inflation outlook based on comprehensive new data on prices, as well as information on demand and output. Members judged it prudent to evaluate those data before considering a further policy adjustment.”

While the governor wrote two weeks ago: “At today's meeting, the board judged the pace of output growth to be somewhat lower than earlier estimated, but also thought it prudent to see forthcoming key data on prices to reassess its outlook for inflation, before considering a further step to ease monetary policy.”

The governor promised a rate cut, CPI data permitting, while the minutes only say it would be considered. If it’s not reading too much into an institution given to careful wording, it might almost look like the Glenn Stevens was at the more dovish end of the RBA spectrum.

On the ever-popular issue of bank-bashing over non-cash-rate-linked interest rate moves, the RBA effectively comes down on the side of the banks again, the minutes noting that while the cost of bond issuance had improved this year, it was still higher than in mid-2011 and a bigger impact was being felt through the competition for domestic term deposits:

“Corporate bond spreads had narrowed further and were now significantly lower than at the beginning of the year, though still higher than in the middle of 2011, particularly for banks. The improved conditions in markets over the past month had led to a high volume of bond issuance. The Australian banks had taken advantage of the improvement in funding conditions to issue a large volume of secured and unsecured debt. Members were briefed on the significant fall in the relative cost of that issuance since the start of the year – around 50 basis points for a five year issue – which would help to alleviate the pressure of higher funding costs in coming months.

“Members noted that a major near-term determinant of funding cost pressures for Australian banks would be the pricing of term deposits. Bank deposits now accounted for more than half of banks' overall funding, with the share having increased from 40 per cent in 2007; within that, term deposits had risen from 30 to 45 per cent of the total. As a consequence of banks competing aggressively for term deposits, their cost had risen materially relative to the cash rate. The relatively short average maturity of term deposits meant that any changes in deposit pricing would flow through relatively quickly to the whole of the banks' deposit books.”

So, no, the pollies’ bank-bashing primarily remains populist politics, not economics.

As for the wide world, it’s more of the same – Europe remains a real worry, the US is improving and China’s reduction in its rate of growth is intentional and not a bad thing. The key message is that, contrary to impression generated by most headlines, our world as defined by our weighted trading partners is growing at about average speed.

And, contrary to what some retailers claim, households have continued to do their bit:

“The national accounts showed that household consumption spending on both goods and services increased by around 3½ per cent over the year to December. This was a little higher than the rise in disposable income over the same period, and it was also stronger than suggested by other partial indicators, including the Bank's retail liaison.”

The weather therefore continues to get much of the blame then for GDP growth being less than predicted for the December quarter, with a dishonourable mention also for the central Queensland coal miners industrial action.

The unanswered question posed in the minutes though is the state of and outlook for our housing industry.

“Members spent some time exploring reasons for the weakness in many of the indicators for housing turnover and building activity across Australia. They noted the apparent sensitivity of developers to the outlook for dwelling prices. New dwelling construction had fallen in the December quarter and there was little sign of a pick-up in building or loan approvals, though house prices had shown some signs of stabilising recently. While auction clearance rates in Sydney and Melbourne had picked up a bit of late, they remained below their average levels.”

It looks like that time spent exploring didn’t result in any significant discoveries. It would remain a brave Treasurer and wishful retailer who would think cutting rates could solve all their problems.

Michael Pascoe is a BusinessDay contributing editor


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