The RBA's pragmatic push-back

Officials in the Reserve Bank are increasingly frustrated at claims it has lost control of monetary policy, and recent comments make it clear the actions of the individual banks are being factored in.

In recent months, senior Reserve Bank officials, including the governor Glenn Stevens, have gone out of their way to say that the central bank remains in control of monetary policy despite the increasingly independent setting of rates by the major banks. Today deputy governor Philip Lowe took that argument a significant step further.

There has been a sense of increasing frustration within the RBA at claims that it has lost control of monetary policy to the major banks as a consequence of their decision to make rate movements above and below the movements in official rates and, in ANZ’s case, to flag that its interest rate committee would meet monthly and review its rates independently of the RBA’s decisions.

At a hearing of the economics committee last month Stevens said the bank had made it "repeatedly clear that the shifting relationship between the cash rate and other interest rates in the economy is a factor that the board takes into consideration in setting the cash rate and that will, of course, remain the case".

"Recent developments (the majors’ decision to raise their home loans despite the cash rate being left unchanged last month) do not in our view materially affect the capacity of monetary policy to achieve its goals."

At that same hearing, assistant governor Guy Debelle articulated the reason for much of the confusion about the relationship between the cash rate and bank interest rates.

He said bank spreads – the rates they pay for their funding relative to benchmark rates, including the cash rate – have gone up. "That is unambiguously the case," he said.

There was, however, some confusion between ’levels’ – the absolute level of rates – and spreads. The levels had in some cases come down, he said, but they just hadn’t fallen as much as the cash rate has fallen.

So, absolute rates – including mortgage rates – have fallen but not as much as the cash rate because the margins, or spreads, over the benchmark rates that the banks have been charged by investors for their own borrowings, including the cash rate, have widened.

Today Lowe, answering questions after giving a speech to the Australian Industry Group in Sydney, said banks’ decisions on rates weren’t a major concern for the RBA.

"The key question for us is, if the banks move independently of the Reserve Bank, whether than undermines the transmission mechanism of monetary policy," he said.

"I think the answer to that is that it does not. It certainly throws sand in the wheels of the transmission mechanism but there are other things that throw sand in the wheels as well."

He said the bank was confident that changes in monetary policy remained a very important influence over lending rates within the economy and that in setting monetary policy the bank took into account what was going on with lending rates.

To reinforce that point, which other senior RBA officials have been making, he said something that ought to give Treasurer Wayne Swan and other strident bank critics paused for very serious thought.

"The current cash rate is at least 100 basis points lower than it would be if this widening in the (bank) margins had not taken place."

In other words, if the banks had simply done as the Treasurer insists they should have and moved rates strictly in line with the RBA’s cash rate the official rate would be 5.25 per cent, or more, rather than its current setting of 4.25 per cent.

What that says very clearly is that, while the RBA might have to try to second-guess the banks’ responses to movements in the cash rates, and there might be occasions where it over-estimates those responses, it is very comfortable that it can factor their likely rate movements into its own decision-making and therefore ensure that it gets the monetary policy settings – and the lending rates – it is targeting.

That process might have been slightly easier when the banks simply passed on the movements in the cash rate but it is obvious from the RBA officials’ commentary that the bank both accepts and understands the funding cost pressures the banks have been experiencing and incorporates into its own rate decisions to ensure that it retains the most decisive influence over the absolute level of interest rates borrowers are being charged.

The way monetary policy is being implemented might have been tinkered with but it is obvious the RBA believes that its pragmatic approach to the position of the banks post-crisis has ensured it remains as effective as it has ever been.

Whether it were achieved by the banks not fully passing on reductions in official rates, or by the RBA not reducing official rates by as much as it has, today’s mortgage and other borrowing rates would therefore be more or less the same, or perhaps even a little higher. It is, of course, a more effective political strategy to accuse the big banks of profiteering rather than criticise the RBA for setting rates it believes are most appropriate for the economy.

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