WEEKEND ECONOMIST: Time to get tough

After revealing very little in the March board minutes, the RBA is expected to emphasise a tightening bias in its April 1 board meeting.

The RBA is widely expected to keep its official cash rate steady at 7.25 per cent at its April 1 Board meeting and markets are now more than fully pricing a quarter point easing by year-end that will take the official cash rate back to 7.00%. But the statement released at the RBA’s post-Board meeting announcement window is likely to be less informative than Governor Stevens appearance before the House Economics Committee on Friday.

While the RBA remains reluctant to articulate a meaningful forward policy bias in its regular statements, the Economics Committee hearings have often seen ad hoc revelations of the RBA’s policy bias, despite the ham-fisted questioning of Committee members. In particular, it seems most unlikely that Governor Stevens would want to validate current market expectations for an easing in policy and rather more likely that Stevens will let slip a more explicit tightening bias than has been evident in the RBA’s recent public comments. This should finally shatter the market’s complacency in relation to future tightening prospects, an outcome we had expected from the release of the March Board minutes, but which did not quite eventuate.

Stevens this week sought to lay to rest the myth that there is a fixed relationship between retail mortgage lending rates and the official cash rate, saying in the prepared text of his Euromoney conference speech that:

"The presumption that their lending rates would and should move only in line with the cash rate, which had arisen in an earlier period when all these rates were much more closely related, has not been a realistic one in the recent environment."

The ad-libbed version of these remarks was phrased somewhat more philosophically. Few people complained when competition from non-bank lenders was driving retail lending rates lower relative to the official cash rate. Now that process has gone into reverse. If financial intermediaries were unable to set mortgage rates to reflect their rising cost of funds, they would be forced to resort to non-price credit rationing, which would have far more serious consequences for the Australian economy than recent market-led increases in retail lending rates.

Monday’s February private sector credit release should confirm that higher credit costs are not unduly constraining credit growth, given the continued strength in income growth associated with the terms of trade boom and a tight labour market. The growth in private sector credit poses a potential challenge to the capital position of local financial intermediaries, but Governor Stevens sounded appropriately relaxed on this issue in his remarks this week. Interestingly enough, the US is in a similar position, with commercial and industrial lending in the US remaining strong, as US borrowers draw down their established credit lines. This is more of a problem for capital-impaired US financial intermediaries, and suggests that the credit crunch for borrowers in the US may only just be beginning. But even for US corporates, internal sources of funding are likely to provide a significant offset to the funds no longer available from capital markets and increasingly scarce bank capital.

Dr Stephen Kirchner is an independent financial market economist. His blog can be read at www.institutional-economics.com

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