Stability is an underrated virtue. Or, put a little more eloquently, exercising the "option to wait” is often underprized or overlooked completely. Human nature means that we tend to be in perpetual mental motion during our waking hours. Sitting, listening and patiently observing does not come easily to us (and this author is the worst offender).
For a taxpayer-owned bank like the RBA, which tries to control the market price of money, there is always a risk of doing too much, of over-tooling its tremendously powerful policy instrument. Weighed against this is the RBA’s odd board composition, which in addition to the Treasurer’s proxy includes six highly conflicted private sector representatives. A new addition to this cabal is the manufacturing industry lobbyist Heather Ridout. Committees are natural breaks on action.
In one of her first post-appointment statements Ridout unwittingly came out and undermined the RBA’s contemporary policy mandate, as stipulated in the five agreements signed by the RBA and the Treasurer of the day since the inaugural "Statement on the Conduct of Monetary Policy” in 2006.
In an interview with Bloomberg, Ridout described herself as a "growth girl”. And "asked if she was a so-called dove, the word used to describe a policy maker who leans toward economic growth over fighting inflation, Ridout agreed she is,” Bloomberg controversially reported.
The RBA and successive Liberal and Labor governments have gone to great lengths to make it clear that the RBA is an "inflation-targeting” central bank. Price stability is its main goal. Other objectives embedded in its original 1959 legislation, such as full employment and the long-term prosperity and welfare of the nation, flow as natural consequences, in the RBA’s view, from it first-order priority of delivering "price stability”.
Indeed, there is a well-known short-term conflict between maintaining low inflation and fostering growth. Over the long-run, however, no such trade-off exists. In the words of the RBA, "price stability is a crucial precondition [emphasis added] for sustained growth in economic activity and employment”. One begets the other. This is endorsed by academic research, which arrives at the obvious conclusion: the most successful central banks focus on a single policy goal, rather than two or three.
Talk of a 'dual mandate' among some economists, egged on by oblique public relations-style references by the governor to the full employment objective in the RBA’s 1959 Act, are – or at least for the past 20 years, have been – a furphy.
It’s quite simple: if Australia has a serious inflation problem, the RBA will use interest rates to staunch those price pressures without consideration for the short-term employment costs. If and only if core inflation is within the RBA’s two per cent to three per cent target band, or expected to fall back into the band, will the bank then contemplate reducing rates to foster more rapid employment growth. It’s an open question whether Heather Ridout appreciates the nuances associated with this distinction.
Returning to my opening remark, there is much to be said for the RBA having an extended pause until the weight of credible economic evidence pushes it in one direction or another. This could involve continued appreciation of the currency (and the trade-weighted index). It could mean a marked deterioration in the labour market signalled by a sustained rise in the unemployment rate. It might involve withering shocks from overseas.
As I’ve argued for years, today’s world is a far more complex, and information-rich, place than it ever has been before. I believe financial markets are getting more volatile (or noisy) as the speed with which information is transmitted has accelerated. There is also a serious question as to how the human brain, having had centuries of conditioning to steady information collection and processing, is currently coping with our new world order in which it is constantly bombarded with conflicting, high-velocity data, much of which is of dubious, unedited quality.
You only need to look at the online headlines run by some of our major newspapers to visualise the problem. These are deliberately designed to shock and awe, and are often misleading. Journalists who consistently peddle the end of the world prosper by grabbing the most eyeballs, which partly explains Steve Keen’s popularity.
I have no hard opinion as yet on what the RBA will do next month. Neither does the bank. Our probabilities shift every day as we learn more about the state of the world. If you want a 'point estimate', I can tell you that the financial markets think the RBA will cut rates in March. My only other contribution at this juncture is that in the absence of new view-changing data, interest rate stability would be a good thing.
In the RBA’s latest Statement on Monetary Policy, the bank has helpfully summarised the current level of lending rates. What we learn is that prior to the circa nine basis point out-of-cycle hike in rates this week, the cost of home loans was slightly below their average since the mid-1990s. The cost of small business and corporate loans was about bang-on average (see the two charts below). This is contextualised against an economy growing "at trend”.
Maybe the bank could do a bit of fine-tuning and chisel rates one notch further. Its cut in December is increasingly looking like a misstep – in the sense that it was not really needed, and may have been better squirreled away for another rainy day. That said, one rate move does not normally change the price of eggs in China. And the out-of-cycle increases by the banks this week actually get the RBA to where it reportedly wanted to be back in December, having (incorrectly) assumed that the banks would only pass on about half the cut. And if we further suppose that the global economy in February is in slightly better shape than the RBA expected in December, rates are possibly a little ahead of where they need to be.
What I will say is that the attempt by ANZ to try and set lending rates independently from the RBA is not overly helpful. Doubtless it helps if you are a bank looking to always maximise your margins unilaterally in order to exceed shareholder return expectations. I have no beef with that.
However, as Steve Muchenberg, the head of the Australian Bankers Association, a little surprisingly notes in the AFR today (in response to Mark Bouris and my op-ed), banks need government support to survive. They are not run-of-the-mill private companies.
With this in mind, Bouris made a comment yesterday that resonated with me. He said, "It’s bad enough that 2 ½ million home owners hold their breath on the first Tuesday of every month in anticipation of the RBA’s rate decision. Now with all of the major banks hitting customers with out-of-cycle rate hikes, mortgage holders are feeling more confused and nervous than ever before.”
Initially, I thought this was just rhetoric. Reflecting a bit further, Bouris’s argument stimulated an insight that I don’t think has been tendered before.
When banks talk about funding cost pressures, they are usually referencing the price of money they borrow from institutional investors. When banks borrow from retail depositors, we give them our money without really thinking about, or charging, a "credit spread” or "risk premium”. We don't say to ourselves, "Gee whiz, ANZ is riskier than Westpac, so I am going to ask for a higher savings rate from ANZ”. Institutional investors, on the other hand, do exactly this.
Yet if we assume that credit spreads are generally stable – that is, there are not large daily swings in the market’s perception of Australian bank risk (given their government guarantees) – then changes in the cost of money that banks borrow should, in fact, be most frequently determined by the RBA’s cash rate, and expected future changes in that rate (as captured by changes in the yield curve). This, after all, is the underlying benchmark rate upon which the banks’ borrowing are priced.
This tells us that most of the time the RBA should control changes in lending rates. But not all of the time. The banking ructions of the past few years have been the exception to this rule. Setting aside the all-important question of what returns government-guaranteed banks need to deliver to their shareholders (likely lower than those the majors currently target), the banks are justified in adjusting their own product costs for changes in funding costs.
But should they try and price their products completely independently of the main driver of that price: the RBA’s monetary policy settings? I don't think so.
Years ago I argued that these out-of-cycle bank moves would make the RBA’s job more difficult and harder to predict. Some dismissed this, claiming that the RBA always determines lending rates and would simply adjust the cash rate until it gets the lending rates it desires.
There is, of course, a delicious contradiction here: on the one hand, we are told that the RBA ultimately sets lending rates; on the other, we are informed that the RBA’s cash rate only influences a minority of bank funding costs. Go figure.
Even with stable bank credit spreads, we have no assurance the oligarchs will comply. With four institutions controlling 80 per cent to 90 per cent of the market, they can simply continue expanding margins. In practice, public pressure will likely prevent this from occurring.
The issue I am more interested in is the RBA’s policy path. It is now undeniable that Australia’s central bank has a much pricklier challenge on its hands with the quasi-private major banks setting lending rates independently of its cash rate.
Ironically, this only serves to underscore the power of the oligopoly. I think it would be smarter public policy and commercial strategy for the banks to embrace Bouris’s suggestion and set rates in lock-step with the RBA with a get-out-of-jail card. If funding costs change to the point where they cannot hit reasonable shareholder return expectations, then they can make their unilateral adjustments.
This, I think, is the way it should be. It would afford much more certainty to the millions of Australian families and business borrowers who are looking over their shoulders right now scared about when the next hike really will arrive. As far as they are concerned, the banks can slam them at any time.
More give, less take, guys…
Christopher Joye is a leading financial economist and a director of Rismark International and Yellow Brick Road Funds Management. The above article is not investment advice.
This article first appeared on Property Observer on February 14. Republished with permission.