The RBA takes an Easter break

Last week, we said our best guess was that Australia’s central bank would pause in its rate hiking cycle this month. That proved correct, with the RBA Board deciding on Tuesday to leave the cash rate target unchanged at 3.6 per cent. Governor Lowe’s accompanying statement listed the likely lagged impact of the 350bp of monetary policy tightening already delivered, indications of an easing in inflationary pressure including last week’s 6.8 per cent print for the monthly CPI Indicator in February 2023, and softening consumer spending, as well as tighter global financial conditions, as among the reasons for the central bank to take a break this month, step back and assess economic developments.

The second part of last week’s prediction was that the RBA would stick with a tightening bias. That call also looks to be broadly correct, with the statement signalling that the Board still thinks some further tightening of monetary policy may be needed. A message that was reinforced by the speech on monetary policy the governor gave the day following the RBA Board meeting, when he noted that the ‘decision to hold rates steady this month does not imply that interest rate increases are over.’ Even so, and consistent with the decision to pause, the fine detail of the messaging delivered this week does suggest that the RBA is now much more prepared to allow for the possibility that it might have done enough relative to where it was just a couple of months ago.

The RBA is still treading its narrow path

The RBA started the current monetary policy tightening cycle in May 2022 with a 25bp increase to the cash rate target. It then continued to tighten over the course of all nine of the following RBA meetings.  Then, after ten consecutive rate hikes and a cumulative 350bp of policy tightening, the Board decided at its meeting on 4 April 2023 that it would make no change to the target cash rate this month, leaving it unchanged at 3.6 per cent. The accompanying statement explained that:

‘This decision follows a cumulative increase in interest rates of 3½ percentage points since May last year. The Board recognises that monetary policy operates with a lag and that the full effect of this substantial increase in interest rates is yet to be felt. The Board took the decision to hold interest rates steady this month to provide additional time to assess the impact of the increase in interest rates to date and the economic outlook.’

As well as references to the need to take time to assess the degree of policy tightening to date and the consequences of monetary policy lags, the Governor’s statement also emphasised: that the recent banking problems in the United States and Switzerland were expected to lead to tighter global financial conditions and therefore add to the headwinds facing the world economy (albeit having little direct impact here in Australia); that recent data releases were consistent with the RBA’s forecast that inflation had peaked in Australia at the end of last year and was now on its way down; and that growth in the domestic economy had slowed, with ‘further evidence that the combination of higher interest rates, cost-of-living pressures and a decline in housing prices is leading to a substantial slowing in household spending.’ (Although with respect to the final item in that list, note that the latest CoreLogic house price data showed dwelling values increasing last month – see below.)

As already noted, the decision to pause this month does not necessarily indicate that the RBA has decided its inflation-fighting job is done. This week’s statement also highlights a still-tight labour market, cautions that while wage growth at its current pace may be consistent with the inflation target (provided productivity growth picks up) the central bank remains vigilant when it comes to the risk of a prices-wage spiral, and emphasises the importance of keeping inflation expectations well-anchored. All of which means that, despite pausing this week, the RBA still retains a tightening bias:

‘The Board expects that some further tightening of monetary policy may well be needed to ensure that inflation returns to target. The decision to hold…provides the Board with more time to assess the state of the economy and the outlook, in an environment of considerable uncertainty. In assessing when and how much further interest rates need to increase, the Board will be paying close attention to…the global economy, trends in household spending and the outlook for inflation and the labour market.’

As explained last week, a tightening bias is not surprising, given that despite recent declines in the monthly indicator, the headline rate of inflation as measured by the quarterly consumer price index (CPI) at 7.8 per cent remains well above target, and that the RBA is only forecasting a gradual pace of disinflation from here. In that context, note that the Q1:2023 quarterly CPI will be published by the ABS on 26 April and that release will have a significant influence on the 2 May RBA monetary policy meeting.

In his speech this week, Governor Lowe noted that the approach taken by the RBA on Tuesday was consistent with past practice in earlier interest rate cycles:

‘In those earlier cycles, it was common for the Board to move interest rates multiple times, then wait for a while to assess the pulse of the economy and move again if the situation warranted doing so. So, it is a return to that world.’

All that said, Australia’s central bank is certainly sounding more dovish than it was just a couple of months ago. The most important evidence of that change is of course the decision to leave the target cash rate unchanged this week. In addition, the language of the statement has also been modified. Readers might recall that at the time of February’s meeting, the RBA was saying that:

‘The Board expects that further increases in interest rates will be needed over the months ahead…In assessing how much further interest rates need to increase, the Board will be paying close attention to…the global economy, trends in household spending and the outlook for inflation and the labour market.’

Comparing that to the corresponding quote from this month’s statement, reported above and we can see that: ‘will be needed’ has been replaced by ‘may well be needed’ and ‘how much further interest rates need to increase’ has been swapped for ‘when and how much further…’ The former change suggests a greater degree of uncertainty as to whether more rate increases will in fact be required while the latter implies less urgency.

So, while the RBA is not ready to say that the tightening cycle is over, it does appear to think that it might be closer to the end of that cycle than it thought was likely to be the case back in February, one additional rate hike on. That in turn reflects the RBA’s continued desire to balance the need to return inflation to target with its efforts to retain as much of the COVID-era fall in unemployment as possible while avoiding tipping the economy into recession.

An update on the state of the housing market

One of the key factor’s sitting behind this shifting monetary policy stance is Martin Place’s view that household spending is now slowing appreciably. Likewise, one of the key risks that the central bank is juggling is uncertainty around the future trajectory of that spending. In that context, an important driver of household confidence and spending intentions is the state of the housing market, and this week saw several related data releases, with home values rising over March even as lending and approvals data signalled ongoing weakness in the residential construction sector.

CoreLogic’s national Home Value Index rose 0.6 per cent over the month in March 2023. Although that still left the index down eight per cent on its March 2022 level, the monthly increase broke the preceding ten-month long streak of declines (starting after April 2022). March’s rise was led by a 0.8 per cent increase in the combined capitals index, with Sydney values up 1.4 per cent over the month, Melbourne up 0.6 per cent, Perth up 0.5 per cent and Brisbane up 0.1 per cent, although values were down across the other capitals, with Hobart experiencing the largest fall (a 0.9 per cent drop). Relative to their recent peak, national home values have now fallen 8.5 per cent, but that has only partially unwound the near-29 per cent increase seen between the COVID-trough and post-COVID peak.

CoreLogic reckons that the price rise last month was driven by a combination of low advertised stock levels, additional demand from overseas migration, and some leakage from extremely tight rental markets. With respect to that third point, capital city house rents have now risen 24.8 per cent since March 2020 and the onset of the pandemic while unit rents have risen 19.5 per cent over the same period.

Looking ahead, CoreLogic noted that the domestic housing market faces a mix of headwinds and tailwinds. The former includes the ongoing impact of past interest rate increases, which have yet to fully flow through to borrowers, weaker economic activity, low levels of consumer sentiment, tight credit conditions and the likelihood of looser labour markets. The latter includes falling inflation, an approaching end to increases in the cash rate, record high rates of net overseas migration and still-low levels of unemployment.

Data from the ABS showed the value of new loan commitments for housing falling 0.9 per cent over the month (seasonally adjusted) in February 2023 to be 30.9 per cent lower over the year.  Loans to owner-occupiers fell 1.2 per cent month-on-month and 30 per cent year-on-year while investor lending was down 0.5 per cent over the month and fell 32.6 per cent in annual terms. The Bureau said that the total value of new housing loan commitments had fallen 33 per cent from the record highs reached in January 2022. Owner-occupier first home buyer lending has likewise fallen from its record high of January 2021 to the lowest level reported since May 2017 and is 27 per cent lower than its pre-pandemic February 2020 level. At the same time, the ABS also said that the value of owner-occupier housing loan refinancing between lenders rose to a new record high in February as borrowers continued to swap lenders in search of lower interest rates.

In other housing-related news, the ABS said that building approvals for private sector houses rose 11.3 per cent over the month (seasonally adjusted) in February 2023 after having fallen to a ten-year low in January. The level of approvals was still 13.6 per cent lower than in the corresponding month last year.  Approvals for private sector dwellings excluding houses slumped 9.5 per cent over the month and were down 45.7 per cent in annual terms, falling to their lowest level recorded since July 2012. A projected decline in residential construction against a backdrop of a resumption in strong population growth due to rapid overseas migration should also imply further pressure on future housing availability.

Last Friday, the RBA reported that total credit for housing rose 0.3 per cent over the month (seasonally adjusted) in February 2023 to be 5.8 per cent higher over the year. The monthly rate of credit growth was unchanged from January’s result.

What else happened on the Australian data front this week?

The Judo Bank Australia Composite PMI (pdf) fell back into negative territory in March 2023, with the output index falling from 50.6 in February to 48.5 last month, signalling a contraction in private sector activity. A faster decline in new orders across both manufacturing and services underpinned the fall in activity, and according to survey respondents a weaker economic backdrop marked by higher inflation and interest rates drove the fall in sales. The Australia Services PMI fell from 50.7 in February to 48.6 in March, indicating a decline in service industry activity for the second time in three months while the Australia Manufacturing PMI (pdf) dipped below 50 (to an index reading of 49.1) for the first time since May 2020. Price pressures also eased last month, with the rate increase in input costs and output prices both slowing, albeit continuing at elevated rates.

The ANZ-Roy Morgan Consumer Confidence Index edged higher by 1.6 points to an index reading of 78.2 last week. Despite the small rise, that result marked the fifth consecutive week that the index has been below 80 – the first time that this has happened since the 1990-91 recession. The weekly inflation expectations index rose to 5.7 per cent.

The ABS published a report on barriers and incentives to labour force participation in Australia, covering the 2020-21 financial year. According to the report, there were 2.8 million people who did not work full-time and who either wanted a job (1.7 million people) or were working part-time and wanted to increase their working hours (1.1 million people).  Of this group, about 14 per cent (or 385,700 people) were not available to work or work more hours within four weeks, of which around two-thirds were women (about 250,000 people). For women, caring for children was the main barrier to labour market participation, applying to about 25 per cent of those not available to work or work more hours (around 61,600 people). For men, the main barrier to participation was long-term sickness or disability, cited by 35 per cent. The ABS also said that for women, the most important incentive to work or to work more hours was the ability to work part-time hours (49 per cent) while for men it was finding a job that matched their skills and experience (43 per cent).

Last Friday, the Department of Finance published the Australian Government General Government Sector Monthly Financial Statements for February 2023. The underlying cash balance for the 2022-23 financial year to end-February was a deficit of $12.9 billion. That represents about a $20.5 billion improvement relative to the October 2022 Budget profile which had anticipated a deficit of $33.4 billion at this point. Government receipts are running about $13 billion ahead of projections, thanks mainly to company tax receipts (almost $6.3 billion larger than budget projections) and income tax receipts (up about $4.5 billion). At the same time, payments are about $7.5 billion lower than expected.

Other things to note . . .

• Resources and energy quarterly: March 2023 edition.  Australia’s resource and energy export earnings are forecast to set a new record of $464 billion in 2022-23, breaking the record of $422 billion set in 2021-22. Exports of iron ore are forecast to fall from $132.5 billion in 2021-22 to a still strong $121 billion in 2022-23 while LNG export revenues are projected to rise from $70.6 billion to a record $90.7 billion over the same period. Australia’s exports of lithium are set to more than triple this year, rising to $18.6 billion from just $5.3 billion in 2021-22. According to the report, by 2028 the export value of lithium and base metals will equal the export value of all coal types.
• The April 2023 RBA Chart Pack.
• Already discussed above, but as well as current monetary policy settings, the RBA Governor’s speech on Monetary policy, demand and supply also covered several other issues including the role of corporate profits in driving inflation (in Lowe’s view, ‘inflation has not been driven by ever-widening profit margins’), and the importance of supply side considerations relating to energy, housing and productivity growth (for example, he identified the discrepancy between rising population growth and a modest expansion in housing supply which is likely to see ‘rents inflation being quite high for a while’ and also noted that, all else equal, a slower-growing supply side of the economy implied a tighter restriction on the pace of future demand growth).
• NAB puts Australia’s insolvency landscape in the spotlight.
• A new research paper from the ABS presents findings from a firm-level analysis of Australian exporter performance with a focus on ‘resilient’ exporters.
• A Treasury working paper seeking to estimate the impact of children on the gender earnings gap in Australia.
• This IMF note looking at international internet adoption trends during COVID-19 finds little evidence of a faster expansion of access to the internet but strong evidence of an improvement in the quality of connectivity.
• The OECD has released its Economic Outlook for Southeast Asia, China and India.
• This Economist magazine briefing on US commercial sanctions on China argues that at minimum the current US-China economic conflict ‘will force a drastic reorganisation of supply chains in the US$570 billion market for computer chips’ but that it ‘may well spill into other industries such a clean technology, biotech and…agriculture.’
• Related, Adam Posen in Foreign Policy on the economics of US-China decoupling. While sympathetic to the case for higher public investment in infrastructure, research and innovation, and for targeted export and investment controls on China and Russia across a limited number of high-technology products, Posen argues that the costs of a broader attempt to decouple the United States from China will outweigh any benefits and may even be counterproductive by eroding US influence on third party countries that find themselves caught up in the shift to a more protectionist stance.
• An FT Big Read on the race for Africa’s lithium.
• New World Bank Research Paper on China as an international lender of last resort.
• Elizabeth Chatterjee says India’s economic model is now one of oligarchic state capitalism.
• TS Lombard’s Dario Perkins on why central bank policy tightening has started to ‘break’ parts of the banking sector.
• Related, All about Bank(Panic)s (pdf) – a report from Goldman Sachs.
• And a warning about nonbank financial sector vulnerability.
• Noted, a new BIS Financial Stability Institute Brief on Macroprudential policies for addressing climate-related financial risks.
• Winners and losers from the introduction of industrial robots.
• On the non-existent future of work.
• At the ‘edge’ of the Universe.
• The Australia in the world podcast considers Cold War 2.0.