Ever since the global financial crisis, the words of central banks have become as important a policy tool as their actions.
The Reserve Bank knows it and investors know it. And the RBA conceded on Friday it had fudged its message to the markets with the rate cut on Tuesday, when its statement triggered the opposite reaction in the dollar and bond yields than intended.
The lack of forward guidance from the RBA on Tuesday was interpreted by traders as signalling the end of the rate cut cycle, sending the Aussie dollar and bond yields sharply higher. The dollar shot up through US80c and the 10-year government bond yield nudged above 3 per cent to a four-month high. Both the dollar and yields would normally fall after a rate cut.
It must have been deeply frustrating for policymakers to see their efforts to weaken the dollar to boost growth and help exporters roundly ignored. Some fund managers said the central bank had “wasted a bullet” by mismanaging its message and trying to keep its options open.
So on Friday, the RBA reinstated its warning to markets that it stands ready to act.
“The board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes,” Reserve Bank governor Glenn Stevens said in the quarterly Statement on Monetary Policy (my emphasis).
That comment should let traders understand that if conditions deteriorate beyond the RBA’s already lowered outlook, it could ease again.
The bank’s forecasts on Friday were more downbeat than in the statement that followed the February rate cut. Despite solid employment growth over the past six months of 160,000 new jobs and hours worked at a four-year high, the RBA now expects the unemployment rate will drift higher and peak later at 6.5 per cent in mid-2016 from 6.2 per cent now.
In keeping with the dour outlook for labour, the bank trimmed its forecast for economic growth by a quarter of a percentage point to 2.5 per cent for 2015.
Because it sees the economy operating with spare capacity “for some time yet” and inflation remaining subdued, the bias to cut rates again is implicit rather than explicit.
The dollar duly softened after the statement by a quarter of a cent, though by late Friday was still one cent higher for the week, and the 10-year bond yield eased to 2.83 per cent. The moves were in the right direction for the domestic economy, but both the dollar and bonds remain hamstrung by a broader unwinding in global markets of earlier fears of deflation.
“It is probably too soon to definitively call the end of the cycle. But we suspect that the RBA will be very reluctant to move below 2 per cent,” said Commonwealth Bank senior economist John Peters.
Glenn Stevens said he wants the latest cut in interest rates to “reinforce” recent encouraging trends in household demand, and maybe the extra $62 a month off the average $400,000 mortgage will give a fillip to consumption. Maybe not.
What the rate cut is much more likely to do is boost auctions this weekend in Sydney and Melbourne. The clearance rates last weekend were a near record 87.3 per cent and 81.3 per cent respectively, on volumes that were 38 per cent higher in Sydney and 60 per cent higher in Melbourne compared with a year earlier.
Beyond this weekend, the cut in official rates and bank mortgage rates (by slightly less) will only encourage further leveraging into the housing market. The central bank appears to have handed all concerns about the bubble in Sydney prices to the prudential regulator and is washing its hands.
This wouldn’t matter so much if private debt levels were not already extremely high and never really corrected after the global financial crisis, unlike in other developed countries.
Data from the Reserve Bank and highlighted by CoreLogic RP Data show the ratio of household debt to disposable income was at a record high 153.8 per cent in December. Housing debt accounts for 91 per cent of the total.
Chart 1: Ratios of debt to disposable income
Source: CoreLogic RP Data, RBA
Within the total housing debt, both owner-occupied and investor housing debt are at record highs as well.
Chart 2: Ratios of housing debt to disposable income
Source: CoreLogic RP Data, RBA
“The fact that household debt levels merely flat-lined rather than reduced following the financial crisis creates some concerns about what will happen once mortgage rates start to normalise,” CoreLogic says.
That moment is further down the track for Australia than for the US Federal Reserve, but it will happen. When it does, the pain for households, especially for any first home buyers who enter a highly elevated market in the interim, will be intense.