The latest communication from the Reserve Bank of Australia has reiterated the 'comfortably on hold' theme established with the move to a neutral stance at its February policy meeting. This week's speech by RBA governor Glenn Stevens on "The Economic Outlook" repeated the line that "... a period of stability in interest rates could be expected" if the economy continues to track in line with forecasts.
That said, there were some notable shifts in tone and emphasis.
The governor saw "encouraging early evidence that the so-called 'handover' from mining-led demand growth to broader private demand growth is beginning". That's a slightly more confident tone than the phrasing used in the February Statement on Monetary Policy (SoMP), e.g. "... reasonable prospects for activity outside the resources sector to pick up over time".
In terms of emphasis, there was again a clear downgrading of concerns around the exchange rate. Although the Australian dollar still rated a mention, this was in the context of the "full panoply of other 'risks'" rather than specific comments about over–valuation and/or the desirability of further declines.
There was also a further shift in assessments around housing. The governor noted "abundant signs of confidence in the housing market" where prices had shown a broad-based 10 per cent rise and were 5 per cent above previous peaks. He expects residential building to rise strongly, referring to "a boom in residential construction over the next two years" in the Q&A. The governor repeated warnings that borrowers needed to take care with increased leverage and that asset prices were "an area to watch". Gains to date were assessed as being within the range of normal cyclical responses but the bank would be monitoring carefully for signs of increased leverage and speculative activity. Lenders were also being scrutinised with the governor noting the Australian Prudential Regulatory Authority would be emphasising the need to maintain high lending standards.
The main caveat to the growth outlook is around non-mining business investment. The governor noted that despite some tentative signs of improvement businesses appeared to still be taking a cautious approach to investment and hiring decisions. He provided more colour on this in the Q&A, observing that business investment had been slow to turn up in previous cycles and that its low sensitivity to interest rate changes meant it was not amenable to 'fine tuning' with policy changes. That tends to underscore the bank's on hold stance – even if non-mining investment remains slow to respond the RBA is likely to be inclined to wait for it to come right rather than go for more interest rate stimulus.
Coming back to the issue of housing, the RBA's half-yearly Financial Stability Review (FSR), released on the same day as the governor's speech, provides a more detailed discussion of financial conditions and risks.
Conditions are assessed as broadly positive. Households' overall financial position was little changed in 2013 and indicators of financial stress generally remain low and "current conditions in the housing market are not assessed as posing a near-term risk to financial stability".
However, the FSR suggests that with household gearing and indebtedness still around historic highs, and with unemployment rising, continued prudent borrowing and saving behaviour is needed to underpin the financial resilience of households.
The RBA adds that recent momentum in household risk appetite and borrowing behaviour warrants continued close observation. Investors' role in the current housing upswing is also discussed, with the conclusion that "on balance, while the pick-up in investor activity in the housing market does not appear to pose near-term risks to financial stability, developments will continue to be monitored closely for signs of excessive speculation and riskier lending practices".
There is a corresponding theme in the commentary on lending. While the RBA states that "lending standards in aggregate have generally been little changed since late 2011" it also cautions that "it is important for banks’ risk management that they are vigilant in maintaining prudent lending standards, given that a combination of historically low interest rates and rising housing prices could encourage speculative activity in the housing market and encourage marginal borrowers to increase debt. APRA’s forthcoming Prudential Practice Guide, which will outline its expectations for prudent housing lending practices, should assist banks in this regard."
A sub-plot in the FSR is the absence of commentary around 'macro- prudential' tools. The minutes to the March RBA Board meeting noted a discussion of how these tools had been utilised abroad and their possible application in Australia. There had been some speculation that this would be fleshed out in the FSR. Note that as a publication, the FSR is part of the RBA's role in maintaining financial stability rather than a monetary policy document like the SoMP. The RBA sees its role here as providing macroprudential analysis that identifies financial system risks that 'micro' prudential regulators (i.e. APRA) can respond to. The RBA has made it clear that it favours this coordinated approach with APRA rather than rules-based measures such as the restrictions on high LVR loans introduced by the Reserve Bank of New Zealand, or counter cyclical capital buffers triggered by a pre-determined threshold metric. More generally, current circumstances in Australia's housing markets are still a world away from the housing boom and rising leverage the RBNZ was trying to rein in when it deployed its macro-prudential measures.
Next week's RBA board meeting is expected to see the cash rate unchanged at 2.50 per cent and a continued 'neutral' stance. Next week also sees updates on private sector credit, dwelling approvals, house prices, retail sales and trade. Our main interest will be in the degree to which strengthening housing markets and easing consumer caution are feeding into credit growth and spending.
Overall, we do not expect the housing upturn to test the RBA's tolerance. Our reading of consumers is that while they are more comfortable with their debt levels, they are unlikely to swing back towards significantly increasing leverage, particularly while they are deeply concerned about their job security. Credit growth is expected to show a modest pick-up but remain constrained by historical standards, with house price growth likely to moderate over 2014.
The Westpac Consumer Sentiment survey is already picking up a notable shift in attitudes towards 'time to buy a dwelling' that coupled with a renewed spike in job-loss fears points to owner– occupier activity flattening out by mid-year. Investor activity is harder to pick, but could also cool quickly if price expectations turn. It would be an unusual turn of events for Australia's housing markets – slowing of its own accord rather than in response to rate rises – but if we are indeed in a new era of caution and balance sheet restraint then this is likely to be how the cycle unfolds.
Matthew Hassan is Westpac's senior economist.