Australian interest rates March 2017

Australian interest rates: firmly on hold supported by experience in 2015-16.

RBA holds ...

As universally expected, the Reserve Bank Board decided to keep the cash rate unchanged at 1.50% at its March policy meeting.

The market was given a clear understanding of the Governor’s intentions when he commented to the House of Representatives Standing Committee on Economics that: “The main effect [of a rate cut] would be more borrowing for housing pushing up house prices.”

... wary of adding further stimulus to housing ...

The Governor is aware of clear evidence that last year’s rate cuts stimulated a strong recovery in house price inflation and household borrowing and he was never going to be of a mood to repeat that exercise in the current environment. That attitude is likely to persist for the remainder of 2017.

... but giving more emphasis to weakness in household incomes.

There were a number of changes in the Governor’s statement accompanying the March decision compared to the same statement in February. In particular there was a more balanced assessment of the current weakness we are seeing in household incomes and the labour market. The Governor referred to the insipid growth in household incomes and linked to that effect the observation that employment growth has been concentrated in part time jobs. Those considerable headwinds for the economy have been known for some time but, recently, he has chosen not to highlight them.

Indeed we have argued that conditions around employment and household incomes are consistent with lower rather than higher rates but that housing market conditions preclude lower rates.

Savings rundown that supported spending ...

As we saw in the December quarter national accounts, the stronger consumption came at a cost of a lower flow into savings with the savings rate dropping sharply. We doubt there is much scope for further large falls in the savings rate given that households are still risk averse.

... unlikely to sustain as consumer caution rises.

On this point, the March Westpac Melbourne Institute Consumer Sentiment survey shows a disturbing deterioration in confidence around household finances and a lift in households’ risk aversion. The subindex tracking views on ‘family finances compared to a year ago’ has fallen 9% since December to its lowest level since June 2014 when respondents were shaken by the Abbott government’s first Budget. A separate question asking consumers about the ‘wisest place for savings’ also shows a clear shift towards risk aversion with the proportion nominating ‘pay down debt’ jumping from 20.5% in December to 25.7% in March, and the proportion favouring real estate dropping to just 11.6%, a record low since the survey began in 1974.

RBA still keeping an eye on AUD ...

Despite the recent fall in the Australian dollar the Governor’s March decision statement retained the standard warning on the exchange rate, namely that: “The depreciation of the exchange rate since 2013 has also assisted the economy in its transition following the mining investment boom. An appreciating exchange rate would complicate this adjustment”.

... recent rises set against a more muted boost from commodity price gains.

On a fair value basis the Australian dollar is justified around current levels, mainly on the basis of current high commodity prices. However, the real economy impacts from the AUD and commodity price mix are somewhat different this time around. Whereas the higher dollar is impacting export competitiveness the commodity price boost to investment and other spending is not materialising. Mining companies are cautious about the sustainability of current prices (we believe appropriately so) so investment and employment has been slow to respond. Other aspects of the boost to demand – e.g. through an improved fiscal outlook – are still likely to be material but the lags associated with this channel are long and we expect that the government will also be cautious about the sustainability of recent gains.

The experience of 2015 and 2016 ...

The Reserve Bank will also be mindful of its experience in 2015/16 when the application of macro prudential policies around investor loans sharply slowed house price inflation. Those policies were complemented by the banks raising rates on investment loans and the standard variable mortgage rate. The combination proved effective, with house price inflation slowing abruptly from a double digit annual pace to flat.

... argue for rates on hold.

Two banks have just announced an increase in mortgage rates on investor loans and a modest increase for owner occupier loans. If the Reserve Bank was to follow this with another round of macro prudential policy measures another abrupt slowdown in house price appreciation would be on the cards. While that might leave the door open for rate cuts in 2018 the lessons of 2016 would be etched in the memories of the officials – better to hold fast in 2018 and certainly no need to raise rates if other policies are achieving that objective.

We remain comfortable with our view that rates will remain on hold in both 2017 and 2018.

Bill Evans, Chief Economist

Reproduced from the March 2017 edition of Westpac's market outlook

Business focus also has the following articles from the March 2017 edition of Westpac's Market Outlook;

Australian dollar March 2017

The Australian economy March 2017

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.