Future challenges will shake the RBA's comfort zone

In today's speech to Parliament, Reserve Bank governor Glenn Stevens appeared sanguine about the economy's present state, despite stepping back from dollar jawboning, but hinted at greater challenges in the medium and longer term.

The Reserve Bank of Australia has reiterated that we are likely to see unchanged interest rates for some time. But for how long? Nobody knows. RBA governor Glenn Stevens talked down house prices, hosed down suggestions of a budget emergency but neglected to say much about the exchange rate.

Stevens addressed the House of Representatives Standing Committee on Economics earlier today, covering a wide variety of topics on the Australian and global economies.

Here are some of the key points:

1.    Interest rates are likely to remain unchanged for some time yet.

Stevens doesn’t know for how long, but for now it appears that the RBA is happy to wait and see whether the non-mining sector can maintain its recent momentum and get a better feel for the likely decline in mining investment.

2.    “People need to keep in mind that [house] prices don’t just rise -- they can fall.”

It was a valid point from Stevens. Nominal house prices have fallen in three of the last five (soon to be six) financial years. Furthermore, in real terms, house prices have had three significant downturns in just the last decade and Sydney prices, after peaking in 2003, didn’t rise for a decade.

It was an obvious point to me because I analyse housing data all the time, but it was a welcome warning to investors and homeowners to not become too enthusiastic. Despite the impression you might get from the mainstream media, house prices really do fall on occasion. Those declines can be quite large and disruptive for households.

3.    Household versus business credit growth

Housing credit has been growing at a healthy pace, gradually picking up, but Stevens does not think that credit growth will return to the 15 to 17 per cent mark that was common in the first half of the previous decade.

If it did, Stevens admits that would be troubling and that it would not be preferable for households to leverage up and increase their debt much higher. On that basis, it appears that Stevens expects housing credit growth to be much lower than in previous decades and that will obviously result in lower house price growth.

By comparison, business credit remains incredibly weak and that poses a problem for the RBA. On one hand, they want to boost business credit and increase investment. But on the other, they are concerned about housing credit picking up much more.

That problem is one of the reasons I have advocated the use of macroprudential policies in the past,  suggesting that the RBA should consider following the Reserve Bank of New Zealand by introducing rules on risky lending (A housing policy lesson from New Zealand, February 19). If it did, it would allow the RBA to better balance the needs of businesses against the enthusiasm of households.

4.    Inflation remains “something of a puzzle”.

Right now, there are two important factors to consider for inflation. First is the effect of the decline in the Australian dollar, which has pushed the cost of tradable goods higher. Second, wage growth has begun to slow and that is putting downward pressure on prices -- mostly for non-tradable goods.

The pressure from the first factor may begin to subside, particularly since the value of the Australian dollar has begun to pick up over the last month or so. That leaves us mostly with poor wage growth. As a result, inflation should remain fairly contained for the foreseeable future. Like the RBA, I’m not too concerned about the recent pick-up in inflation.

5.    We don’t have an immediate budget problem but a medium-term issue

Stevens emphasised that Australia does not currently have a budget emergency. Despite the political theatrics over the budget, our level of net government debt is fairly low by international standards and there is absolutely zero chance that we could default on our immediate debt obligations.

That said we obviously have some pressing medium and long-term budget issues. As Stevens said, there are a number of social programs that are unfunded over the medium term. Eventually there will be big budget issues arising from an ageing population and the rise in aged care and health expenditure that will accompany that development.

In addressing these issues, the government should be more concerned with structural issues rather than penny pinching around the margin. Unless they address welfare, health expenditure and the tax base itself, the government will only manage to stall the eventual budget emergency while solving the current non-existent one.

6.    Little said on the exchange rate.

Stevens had ample opportunity to talk down the Australian dollar but chose not to. The RBA’s jawboning of the currency has dropped off significantly in recent months, suggesting that either it is no longer needed or that the RBA believes it isn’t working.

I’m inclined to believe the latter and the recent pick-up in the exchange rate will prove problematic for the non-mining economy. But it is clear that the RBA is not willing to do much to bring down the currency, whether via interest rate cuts or other measures.

The parliamentary testimony covered a wide range of topics and the quality of the discussion was far greater and less political than in December (The RBA’s steely infrastructure warning, December 18). It is clear that the RBA is fairly content with the state of the economy and that recent data strength in retail sales and GDP hasn’t really changed their outlook. The economy has developed in a way that would certainly please the RBA, but it knows perfectly well that greater challenges lie in the future.

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