Following on from ANZ raising its interest rates on Friday, I've summarised the results of Bloomberg's RBA cash rate survey into the chart below. Bloomberg has polled 24 economists after ANZ's decision, and I've shown the high/low forecast for each period in addition to the "median" (middle observation) and "average".
The "median" (red line) economist expects a 0.25 percentage point (or "basis point") rate cut in May followed by interest rate stability until the first quarter of next year. The median then forecasts one hike back to 4.25% in 2013. My own May forecast is currently a "more likely than not" 25-basis-point cut subject to the inflation results on the 24th, which could stay the RBA's hand.
The "average" economist prediction (orange line) is very similar: the average thinks there is a chance the RBA does not cut in May, albeit this is a slim prospect given the average expectation is 4.03% by May. The average then thinks there is a non-zero chance of a total of two rate cuts this year, and prices in a cash rate of 3.92% until the fourth quarter. The average subsequently starts pricing in rate hikes in 2013.
The dotted lines in the chart show the highest and lowest forecasts. The lowest any of the 24 economists surveyed see the cash rate going is 3.75%, which implies two more cuts. In contrast, the highest see no cuts at all this year, and a first hike by Q1 next year.
Aussie Home Loans executive chairman John Symond has warned a standard 0.25 percentage point easing by the RBA at its May meeting would not be enough, given the banks have lifted home loan rates since the last cash rate cut in December.
“We have a situation where since Christmas we have had two increases by the banks out of cycle. So, 25 basis points is just playing catch-up for the punter,” Symond suggests.
“If the Reserve Bank wants to make a difference and instil confidence, they now have to go more than 25 basis points and go 50 basis points,” Fairfax Media reported Symond as saying today.
Last month the Aussie Home Loans founder said the RBA was “a bit out of touch by not accepting that parts of the economy, especially small businesses, is doing it really tough at the moment”.
“As well as the Australian economy has performed relative to other economies, we could easily get into the situation where the economy could stall,” warned Symond.
“We need an injection of good news and an injection of confidence – the best way to do that is to start dropping interest rates.”
The Reserve Bank of Australia kept rates on hold at its April meeting despite spending “some time” exploring reasons for the weakness in many of the indicators for housing turnover and building activity across Australia.
But taking into account other factors, the board decided a month’s delay in any further cutting of rates was the prudent thing to do.
“They noted the apparent sensitivity of developers to the outlook for dwelling prices,” the RBA minutes note.
“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,” the RBA minutes note.
But the board, noting it had eased monetary policy late in 2011, concluded slower growth in demand could be expected to result in a more moderate inflation outcome, which might then present a case for a further easing of monetary policy.
Last Tuesday I predicted ANZ would hike rates by between five basis points and 7.5 basis points, and noted that this could be a bit of a game-changer for the RBA’s May meeting.
On Friday the bank lifted them by six. While this is bad news for ANZ borrowers, it was a commercially astute decision for the bank and its shareholders for a variety of reasons.
First, Friday’s hike will improve the bank’s profit margins, which is important for banks in an environment in which revenues are growing slowly and the historical returns on shareholder equity will be difficult to maintain.
Second, it starkly reinforces ANZ’s (superficial) argument that there is a big conceptual disconnect between the lending rates banks set and the cash rate that the RBA targets.
As I have shown before, this is more fiction than fact and confuses changes in profit margins with the actual level of lending rates. To be sure, changes in funding costs will directly affect profit margins, unless product prices are varied accordingly. The question then turns to what “reasonable” and “competitive market” profit margins should look like. That is a debate I’ve tried to stimulate for years, but it remains largely unresolved.
In terms of the actual level of borrowing rates, the RBA is, on average, the ultimate arbiter of the price of money in the Australian economy.
The third factor that makes ANZ’s decision smart is that it amplifies the pressure on the RBA to cut rates in May. To be clear, a rate cut is by no means certain. If we get a high “core” or “underlying” quarterly inflation print on April 24 of 0.8% or more, and the historical inflation data does not revise down (or revises up), then the chances are that the RBA will leave rates unchanged.
Upping the ante on the RBA to drop rates further in May is important to the banks for two reasons. First, it gives them another bite at the profit expansion cherry: they can choose not to pass on the full 25-basis-point RBA cut and internalise this as margin.
In 2012 ANZ has taken back about 60% of the RBA’s second, December rate cut. But actual lending rates are still lower than they were at the end of November, and will be lower again should the RBA be convinced that it can justify pulling its trigger finger a third time.
A second reason why the banks want a rate cut in May is because, all things being equal, banks do better in lower interest rate environments. Credit growth and revenues accelerate, default rates and impairments typically decline, and asset prices and hence collateral values rise.
A final point to recognise is that wider bank margins will probably help encourage more competition in the long run. It will give nimbler players with lower cost bases (but higher absolute funding charges) a better chance of competing with the major bank oligopoly, which has numerous institutionalised advantages.
The Australian economy continues to perform weakly, an industry study has found.
The Westpac-Melbourne Institute leading index of economic activity, which indicates the likely pace of activity three to nine months into the future, posted an annualised growth rate of 2.4 per cent in February.
This placed it below its long-term trend of 2.9 per cent, Westpac said today. It was the sixth consecutive month with a below-trend reading.
Westpac chief economist Bill Evans said the result was in line with the bank’s predictions for growth in the domestic economy in the short term.
‘‘The growth rate has picked up somewhat from the absolute low in November last year,’’ he said. ‘‘But the modest decline in February does not encourage too much optimism that growth is likely to exceed trend any time soon.
‘‘That profile is consistent with Westpac’s forecast for growth in the Australian economy in 2012 of 3 per cent which would mean that Australia had grown below trend for five consecutive years.’’
Mr Evans said the weak and patchy growth trend would mean the Reserve Bank of Australia (RBA) had a strong case for easing the cash rate at its next meeting, in May.
‘‘Following the release of the board minutes for the previous meeting on April 3 it is apparent that the case for a rate cut is strong,’’ he said. ‘‘The board is concerned about the sharp differences between sectors and regions, recognises that there is a significant fiscal tightening, and notes that non-mining investment was likely to remain sluggish.
‘‘There is a clear observation that, subject to the inflation outlook remaining benign, there is scope to cut rates.’’
In a not surprising (for readers of this column) attempt to politically pressure Australia's central bank, a major media outlet reports today that the prime minister has broken with historical convention – for an incumbent government – and called on the Reserve Bank to lower interest rates given the government's mooted fiscal promises.
This is after the current Labor government controversially took away the Reserve Bank board's pay-setting powers because they were too generous with the governor's salary package, replaced one independent (and hawkish) director with a manufacturing industry lobbyist who describes herself as a "growth girl" and an inflation "dove", and broke with long-term convention by replacing the board's standing independent academic expert (another hawk, Professor Warwick McKibbin, who had offered himself up for re-election) with a former advisor to a Labor prime minister, Paul Keating.
Some have also observed that while the current RBA governor contentiously hiked rates in the final month of the 2007 election campaign as the global financial crisis was brewing – an election that the Liberal Party lost that month – he did not touch rates during the subsequent 2010 campaign despite possessing a hawkish bias, waiting until November to raise them pointedly after Labor had scraped home with a hung parliament.
In a panel interview with Bloomberg yesterday, former RBA board member Professor McKibbin described the government’s recent elections to the RBA board as "disconcerting".
Professor McKibbin advocated a board structure comprising of three RBA staffers (currently there are only two), three independent economics experts (currently there is one), and three "community representatives" with no politically-appointed treasury secretary.
The Australian Financial Review reports that today:
Prime Minister Julia Gillard will aggressively link her budget surplus goal directly to lower interest rates, saying that the Reserve Bank of Australia has “plenty of room” to cut its 4.25 per cent cash rate... Her speech to business leaders in Perth will also make the case for a reweighting of monetary policy which could help push down the Australian dollar and provide relief to manufacturers, exporters and the tourist industry. In effect putting the political success of next month’s budget into the hands of the Reserve Bank board, Gillard will say that the large interest rate differential between Australia and offshore markets gives the RBA “plenty of room to move further if need be”.
The prime minister is quoted apparently calling on Australia's central bank to re-focus on its antediluvian 1959 mandate, which requires it to give equal weight to employment, growth, and price stability.
Since that time, however, the treasurer of the day and the governor of the RBA have signed a total five "Statements on the Conduct of Monetary Policy" that explicitly subordinate the employment and growth goals in the 1959 Act to allow the RBA to focus mainly on one medium-term objective: price stability. Specifically, the latest statement signed by Wayne Swan and Glenn Stevens says (emphasis added):
"Since the early 1990s, inflation targeting has formed the basis of Australia's monetary policy framework. Since 1996, this framework has been formalised in a Statement on the Conduct of Monetary Policy. The inflation targeting framework has served Australia well and is reaffirmed in the current statement...
"[The three objectives outlined by the 1959 Act] allow the Reserve Bank board to focus on price (currency) stability while taking account of the implications of monetary policy for activity and, therefore, employment in the short term. Price stability is a crucial precondition for sustained growth in economic activity and employment.
"Both the Reserve Bank and the government agree on the importance of low inflation and low inflation expectations...[and] on the objective of keeping consumer price inflation between 2 and 3 per cent, on average, over the cycle."
In today's leaked speech the prime minister seems to confuse these priorities. Without having the benefit of the first quarter inflation results, which are expected to be benign, or revisions to the 2011 inflation numbers, the prime minister advocates the employment and growth benefits of lower rates with inflation-targeting added as an afterthought:
“In the current economic environment, should the bank consider it appropriate to change the cash rate, this could deliver widespread benefits for households and business – noting that a number of sectors of the economy most under strain are arguably more sensitive to interest rates...This is fully consistent with the Reserve Bank’s charter obligations to best contribute to economic prosperity and full employment, as well as containing inflation.”
One problem for the Reserve Bank is, as Professor McKibbin explained yesterday, that the current government's forecasts and commitments to fiscal contraction are already accounted for in the central bank's analysis (since Treasury have always projected a steep fiscal consolidation following a fiscal stimulus that McKibbin believes was twice as large as it needed to be), and are, in any event, merely political promises.
At the invitation-only Bloomberg conference, McKibbin argued that the Reserve Bank would be far more focused on what policies the government actually delivers, given its history of missing commitments. He also suggested that it was unreasonable to ask the bank to make decisions today on the basis of assumed budget outcomes before it had the benefit of both seeing what is promised on May 8, and what the government ultimately delivers.
A very good AFR editorial today--likely from Mitchell or Stutchbury:
Misplaced faith in lower rates THE AUSTRALIAN FINANCIAL REVIEW
Legitimate debate about the decisions of a central bank can quickly slide into a concerted campaign for soft monetary policy, so the federal government’s top minister should be careful not to be seen to be pressuring the Reserve Bank of Australia into putting its short-term political interests ahead of the longer-run goal of economic stability. The RBA is highly respected internationally for the way it has shepherded the economy through global volatility over the past two decades. Opinion polls show 85 per cent of informed voters approve of the way governor Glenn Stevens has done his job.
No individual government action has obviously stepped over the line. But acts in concert raise a warning flag about the bank’s independence and hence its low inflation credibility. Any doubts about this would build a risk premium into the price that lenders demand for using their money. That is, it would put upward pressure on interest rates.
The government’s actions further run the risk of encouraging the business sector to think that the solution for our present problems lies in the easy option of lower interest rates.
Instead, the solution lies with government and business facing up to the major adjustment in the economy resulting from the gift of high commodity export prices, the resulting strong dollar and from changing technology. A cut in rates is not going to stop that structural change.
The government is right to pursue a budget surplus. But in a speech to business leaders in Perth yesterday, Prime Minister Julia Gillard made a point of linking a budget surplus to a rate cut, declaring that the surplus gave the RBA “plenty of room” to cut its 4.25 per cent cash rate. She said monetary policy should be reweighted away from fighting inflation towards pushing down the Australian dollar, to provide relief to manufacturers.
Economic policy does need to be reweighted away from monetary policy (and the exchange rate) and towards fiscal policy, which is structurally too loose. Highlighting this is a legitimate part of selling the politics of getting the budget back to surplus, where it should have been over the past several years as commodity prices soared to 170-year highs.
Yet, along with bashing the banks over interest rates, Treasurer Wayne Swan has stripped the RBA board’s power to set competitive pay rates for top staff, even amid protests from board member Jillian Broadbent. Its board appointments have been on the “dovish” side, including a lobbyist for manufacturing. And fellow labour-movement travellers such as Australian Workers Union boss Paul Howes have established a drumbeat of demands for lower interest rates and a weaker dollar, even suggesting the RBA’s charter should be torn up. Industry Minister Greg Combet was ill-advised to be standing next to Mr Howes when he publicly launched such a tirade.
As it happens, the RBA is generally expected to cut rates at its meeting early next month if the consumer price index next week shows inflation anchored in its 2 to 3 per cent target. But with the economy almost at full employment and growing near its sustainable trend, a cut in the cash rate may do little more than stimulate real estate prices.
A better approach would be for government and industry to focus more on lifting productivity, as recommended this week by veteran waterfront reformer Chris Corrigan and as demonstrated by Toyota Australia’s bold confrontation of the worst elements of the nation’s industrial relations culture.
Put yourself into the shoes of thousands of Australians who own small businesses across the country right now.
You're faced with a serious drop in demand for your product, and you need to get turnover moving quick smart, to start shifting that product off the shelves.
What do you do? You don't need to be versed in the subtleties of economic theory to work it out. The answer is simple. You cut your price, or at the very least offer a better, more competitive service.
That is exactly what is happening across Australia and throughout the developed world. That debt-fuelled consumerism of the past few decades suddenly has been replaced by a new conservatism when it comes to purchasing goods and has been accompanied by an aversion to debt.
Our retail malls, once proudly displaying two discounted sales a year, now are permanently emblazoned with discount banners, promising 30 per cent, 50 per cent or even more off the ''regular'' price.
Our banks are faced with the very same dilemma. Month after month, the Australian Bureau of Statistics unveils figures detailing a drop in lending for new housing and for business, falls to levels not seen in decades, sometimes of a magnitude never before recorded. No-one is borrowing.
But the response from our lending institutions has run counter to the most fundamental laws of economics and logic and, in so doing, they may well be laying the foundations for serious financial problems for themselves and the nation.
Rather than cut their margins, and lower their interest rates in an effort to spur demand for new lending, they have spent the past few years raising the cost of money to existing customers to compensate for the lack of growth in their lending.
It's a short-term solution to their predicament. It may temporarily boost profits. But it dampens demand for debt. That, in turn, can work in a far more insidious manner to undermine the health of our economy, our financial system and our lending institutions by creating a liquidity trap. More on that later.
Do people really think cutting by 50 points will make people more confident? A 50 point cut generally means that we are in serious trouble. Fan is on full and catapult loaded with poo. 50 points means 'we read it really wrong last time, and everything has gone pear shaped'. Is that where we are? I don't think so. I think a 25 point cut is hard to justify, but there is so much pressure it may happen. But more? Seriously?
Whenever you have an argument with someone, there comes a moment where you must ask yourself, whatever your political persuasion, 'am I the Nazi?'
At the Fruity Blooms food stall across the street from Australia's central bank, the recent return of one customer may offer the biggest clue that inflation pressures are easing.
The Reserve Bank of Australia governor, Glenn Stevens, has resumed buying bananas at the stand since the price fell to $1 in the past three months from as high as $3 last year in the aftermath of crop damage in the nation's north, according to the stall's owner.
''He used to buy a banana a day off me,'' then stopped coming, says David Bisoglio, who's run the stall at Martin Place in Sydney for the past eight years.
''In the last three months, he's come back,'' says Bisoglio, 32. ''He makes the comment 'oh, it's nice to see bananas are back to the normal price'.''
Across Australia, the breaking of nearly a decade of drought and a historically mild summer have caused a glut of fresh fruit and vegetables, driving down market prices by about 25 per cent from a year ago. That may help pave the way for Stevens to cut interest rates, as the nation's inflation-linked bond market underscores the retreat in price pressures.
''It looks like there's quite a big fall in fruit and veg prices coming through in the first quarter and part of this is the final leg of the banana story,'' says Michael Blythe, chief economist in Sydney at Commonwealth Bank of Australia, who estimates consumer prices rose 2.1 per cent last quarter from a year ago, and core inflation was 2.4 per cent. ''These numbers don't look like they'll be standing in the way of a rate cut.''
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