Reserve Bank policy benchmarks not in sight yetReserve Bank Governor Testimony
Reserve Bank Governor Testimony: Reserve Bank Governor Philip Lowe has appeared before the House of Representatives Standing Committee on Economics. Testimony by the Reserve Bank Governor can have a major impact on interest rate expectations.
What does it all mean?
The Reserve Bank Governor Philip Lowe’s commentary was very similar to the Board’s Statement on Monetary Policy released a week ago. However, his comments today provided more clarity and reinforced our view that interest rates are likely to remain on hold for the foreseeable future.
Once again, the Governor reiterated his view that should the economy continue on its current trajectory, “It is more likely that the next move in interest rates will be an increase, not a decrease.”
But the Board remains pragmatic and will patiently wait until it meets its key policy objectives before adjusting interest rates. He noted, “It is likely to be some time before we are at full employment and the inflation rate is comfortably within the target range on a sustained basis. We are prepared to maintain the current monetary policy stance until these benchmarks are more clearly in sight.”
As expected, the Governor continued with his upbeat assessment of the Australian economy. Much of the parliamentarian “Questions and Answers” were devoted to wages growth. The transmission from strong employment growth to higher wages and inflation is expected to occur only gradually over time, despite skills shortages emerging in some industries, primarily information technology and engineering construction.
Positive developments around female participation in the labour force, together with the narrowing of the gender pay gap, as evidenced in yesterday’s average weekly earnings release, were discussed.
The Governor also noted that government policies, which should see lower electricity and child care administered prices, will be a drag on inflation in the near term, but will be a relief to household budgets under pressure from anaemic income growth. Dr. Lowe referred to this development as “good news” as it may encourage greater consumer and business spending.
On the housing market, the Governor welcomed the cooling of home prices in Sydney and Melbourne with longer term gains considered “not sustainable and posing a medium term risk to our economy”. He also focused on the weakening in demand from investors as the key catalyst for falling home prices in these cities.
Dr. Lowe also applauded the Turnbull government for getting its fiscal house in order. He said, “Its good news that the Budget is on a sustainable track. Australia has gone a long time without having a recession. One day we will have one…. when that day comes it will be useful if the government has the financial capacity to help stimulate the economy. So the job just isn’t left to monetary policy.”
Risks around trade and the spiralling US Budget deficit and debt situation were a key focus. And the lower Aussie dollar was considered a plus for the economy, particularly exporters. Concerns around the impact of the drought on rural exports was also discussed, but a short term lift in exports may occur as meat slaughter rates increase, despite falling grain production. 
Interest rate outlook: “The Board’s view is that it is likely that we will hold steady for a while yet. It is likely to be some time before we are at full employment and the inflation rate is comfortably within the target range on a sustained basis. We are prepared to maintain the current monetary policy stance until these benchmarks are more clearly in sight…. with the central scenario being for the economy to continue on its recent track, it is more likely that the next move in interest rates will be an increase, not a decrease.”
On economic growth: “Since we last met, the Australian economy has continued to move in the right direction. According to the most recent data, GDP growth is 3.1 per cent…the Australian economy looks to have grown strongly over the first half of 2018. GDP increased by 1 per cent in the March quarter and a reasonable increase is expected in the June quarter. Business conditions are positive and we are in the midst of an upswing in nonmining business investment. Increased spending on infrastructure is also helping. Resource exports are also increasing strongly as new capacity comes on stream, particularly for LNG. One important offsetting factor is the drought in eastern Australia. While the prices of some farm products are currently quite high, the dry conditions will limit farm production.”
On inflation: “The CPI inflation rate – at 2.1 per cent – is higher than it was a couple of years ago, but still below the medium-term average. Strong competition in retailing from new entrants is holding down the prices of many goods and low wage increases are holding down the prices of many services. Rent inflation is also at a very low level. Working in the other direction over the past year has been higher prices for electricity, fuel and tobacco. We are expecting inflation to move gradually higher over the next couple of years as the economy strengthens.”
On inflation targeting: “We remain committed to achieving an average rate of inflation over time of between 2 and 3 per cent.”
Household sector: “The housing markets in Sydney and Melbourne have clearly slowed and prices are coming down. While this has concerned some people, we need to keep things in perspective. Not so long ago, there was concern in the community about rapidly rising housing prices and debt and declining housing affordability. These earlier trends were not sustainable and were posing a medium-term risk to our economy. So a pull-back is a welcome development and can put the market on a more sustainable footing…All these things are helping with the adjustment. We are nevertheless continuing to keep a close eye on housing market developments across the country.”
Housing credit growth: “The slowing in the housing market has reduced the demand for credit by investors. There has also been some tightening in the supply of credit, partly in response to the Royal Commission, although the main story is one of reduced demand. The average variable interest rate paid by borrowers has declined further over the past six months, to be about 10 basis points lower than a year ago. You would not have expected to have seen this if supply constraints were the main reason for slower credit growth.”
Employment: “This week, we also received employment data for the month of July. While the month-to-month employment data are volatile, the unemployment rate has fallen to 5.3 per cent, which is the lowest it has been for some years… the number of job vacancies, as a share of the labour force, is at a record high. Firms are reporting that it is harder to find workers with the necessary skills, and survey-based measures of hiring intensions remain positive.
Wages growth: “….a lift in aggregate wages growth would be a welcome development from several perspectives. It would contribute to inflation being closer to the midpoint of the inflation target. Stronger income growth would also help in the context of high levels of household debt. It would also be of benefit to government finances and more generally would strengthen our sense of shared prosperity. And, to the extent that stronger wages growth is backed by stronger productivity growth, it would boost our real incomes….data are consistent with our view that wages growth and inflation will pick up gradually over the next couple of years as the labour market continues to tighten… In our liaison program we also hear reports of larger wage increases for certain occupations where workers with the necessary skills are in short supply…. Even so, the pick-up in wages growth is still expected to be fairly gradual. We still have some spare capacity in the labour market, including part-time workers who would like more hours. There are also structural factors at work, arising from technology and competition that we have discussed at previous hearings.”
Global growth: “The global outlook remains positive, although a number of risks have increased…. In China, growth has slowed a little. The authorities have responded to this, although they also face the challenge of addressing risks in the financial system.” Questions & answers
Labour market: “Over the past year the Australian economy has been growing above trend eating into spare capacity. The economy growing at 3 per cent should see the unemployment rate come down and that’s what’s happening. There are few things supporting that. The global economy is growing quite well at the moment. The global backdrop for Australia is quite positive. Commodity prices are higher than a year ago, creating extra income in Australia. There has been a very strong lift in infrastructure investment, particularly in the eastern states. The low level of interest rates are also helping. Now that the resources boom is over there is more scope businesses outside the resources sector to increase their capital spending. Collectively those factors are generating strong demand for labour, lowering the unemployment rate. Over the past year employment is up around 2.5 per cent. The participation rate has also been rising…creating opportunities for older workers… its encouraging there has been a marked decline in youth unemployment over the past six months. The labour market is good.”
Wages growth: “Wages growth is heading in the right trajectory, but only slowly. The number of job vacancies that firms have as a share of the labour force is the highest on record. Firms are advertising a lot of jobs and they are telling us that it is hard to find workers. In that environment you’d expect wages growth to pick-up. Our business liaison program are telling us that project management skills, information technology security, engineers, and specific skills in the construction sector, specifically infrastructure-related occupations. Wages are starting tomove. It will become a more general story but it is going to be a gradual process. But in many occupations wages growth is around the 2 per cent mark. In the most recent Enterprise Agreement Bargaining (EBA) process growth was still quite low…… it is going to be a gradual process. One part of our strategy is to try and stop wages growth expectations falling. And the other part is keep interest rate low for a long period of time.”
Labour market participation: “More than the average share of jobs are going to women, leading to greater female participation in the workforce. Older workers are staying in the workforce which is a longer term trend. Better health outcomes might be driving this. For women in their middle years it is quite common in good economic times for those not currently in the labour force to decide to re-enter the labour force at a particular time. Many of these women will have been out of the labour force caring for their children or studying. A lot of the full-time jobs created over the past year have gone to women. Employment in the healthcare sector has been strong, employing a lot of women. Typically hires people from out of the labour force. One of the developments showing that there has been a strong cyclical period in the labour market.”
Inflation: “Many households have cost of living pressures. Lower electricity prices, lower cost of childcare and lower costs in New South Wales for car registration and tolls are all going to help with the cost of living pressures that households face. In the short term they are going to lead to lower inflation. And this because of decisions made by governments to reduce the cost of living pressures on households. People will have more money to spend on other things, creating more demand elsewhere in the economy and gradually lift spending and prices. If you are looking at inflation picking up to 2.5 per  cent it is not so helpful. Its ambiguously good news…. For a number of years rising electricity and gas pressures have put upward pressure on consumer prices. It would be good if those days are behind us. It’s also the cost of production for many businesses. Having some certainty about the energy future will help business investment. A number of firms have been delaying investing.”
Federal Budget: “Its good news that the Budget is on a sustainable track. The first is from an insurance perspective. Australia has gone a long time without having a recession. One day we will have one…. When that day comes it will be useful if the government has the financial capacity to help stimulate the economy. So the job just isn’t left to monetary policy. The government needs to run disciplined budgets in good times. I also worry about intergenerational equity. Whether it is right for our generation to continue financing services and government expenditure using debt which our children will have to pay back.”
Corporate taxes: “There is a form of international tax competition going on. Corporate tax cuts have stimulated the US economy and other countries are responding. If we are to respond the Budget needs to stay on a sustainable track.”
Housing market: “The main thing effecting the housing market is the shift in the underlying dynamics between supply and demand. There has been a lot of extra construction… the number of dwellings is rising more quickly than it has been for a long time. There is less demand from China. The level of prices had got so high that people are no longer prepared to keep bidding the prices up much further. So now prices are falling and when prices are falling investors are not as keen to go to their bank to borrow to buy because the value of the asset could be 5 per cent lower in six months’ time. There has been a reduced demand from investors for credit. I don’t think the supply side is the main story.”
US Budget deficit: “US Budget deficit as a share of GDP is 4 or 5 per cent at a time when the US economy is below full employment, is growing above trend and has a very high level of public debt. Public finances in the US are looking problematic. At this time in the cycle it should be back to Budget balance or better than that. Governments are responding to disillusionment in the electorate and international tax competition by cutting taxes or spending more money. In the OECD economies more than half are having a fiscal expansion this year at a time when the world economy is doing well and unemployment rates are low. Levels of public debt are very high. Australia is not doing that.”
Australian dollar: “A lower exchange rate would be better than a higher one. It would lift inflation to mid-point of the inflation target range and stimulate our economy, supporting our exports, creating more jobs, wealth and income. We were hoping that rising US interest rates would lift the US dollar, our exchange rate would fall, stimulating the economy so that we could normalise interest rates. The process has taken a lot of time to occur. The Australian dollar has not moved that much. A lower dollar would be helpful for inflation and employment.”
Global growth: “Concerns over trade lie at the heart of recent IMF downgrades to growth in some economies. I can’t think of a single country that has made itself wealthier by building barriers. Tariffs of 10-25 per cent in the US and China slows growth only a little bit. Australia will be moderately effected. If tensions escalate businesses around the world will be nervous and decide not to invest or delay. Businesses hate uncertainty. We are seeing that in North America. If this occurred at the same time that financial markets became jittery this could be a damaging cocktail. Tensions may lead to liberalisation and further integration within NAFTA. And the Chinese take more seriously the challenge of intellectual property.”
Drought: “In Western Australia conditions are quite good at the moment. Northern Queensland has also had some rain. Parts of New South Wales into Southern Queensland and northern Victoria the drought is very serious. Slaughter rates are increasing, leading to a short term boost to meat exports. But that will be offset by lower grain exports. Less income in rural communities and less spending. Rural exports account for up to 15 per cent of total exports and will be lower in the next few years.”
What are the implications for interest rates and investors?
The latest comments from the Reserve Bank Governor support the view that interest rate settings will be stable for some time yet.
Dr. Lowe’s introductory commentary was particularly instructive on the current economic scorecard. In his ‘heat map’ he said, “GDP growth is 3.1 per cent, inflation is around 2 per cent and the unemployment rate is now below 5½ per cent. In the broad sweep of our economic history, these are a pretty good set of numbers. But we are still short of full employment and we would like to be more confident that inflation will be sustained at a level consistent with the target.”
CommSec expects no change in official interest rates until 2019.
Published by Ryan Felsman, Senior Economist, CommSec