Credit boom unlikely to return but lower rates the new normal: Philip Lowe

The RBA will continue to maintain a low cash rate setting, according to RBA deputy governor Philip Lowe.

He says Australia now has lower interest rates than it otherwise would have to offset some of the effects of an uncomfortably high exchange rate and in an environment of slower credit growth and greater consumer caution.

But he said it was possible that “normal lending rates will be somewhat lower for a period owing to the combination of global factors and the legacy of the credit boom”.

These remarks where part of a speech delivered in Sydney overnight following the RBA cutting the cash rate to 3% and to its lowest level since the GFC.

Speaking on the topic of “What is normal?” Lowe highlighted how it was now much harder for the RBA to judge what an appropriate economic response was to rate cuts, but re-affirmed that the RBA continues to believe that monetary policy continued to keep inflation in check and have a positive impact on the economy.

“Monetary policy still looks like it is working,” Lowe said.

“There are lags and different parts of the economy respond differently, but lower interest rates are still effective in providing a boost to the overall economy.”

But he also provided numerous examples of how the economy has shifted since the GFC and that a new "normal" had emerged.

He said the Australian propensity to spend every dollar earned between the mid-1980s and into the 2000s (as house prices boomed) was not normal and that “more recently, the saving rate has increased and it is back to the level it was in the mid-1980s”.

Lowe said the lower cash rate settings were also in response to higher funding costs facing banks, meaning they no longer moved in step with the RBA.

Lowe said that in a new “normal” of lower credit growth and higher funding costs for banks, the cash rate was currently around 150 basis points lower than it otherwise would have been.

“The fact that the bank has offset the effect of higher funding costs on lending rates means that the normal level of the cash rate is lower than it otherwise would have been,” said Lowe.

“A 3% cash rate today is not the same as a 3% cash rate in the past,” he added, implying that this was because headline mortgage rates offered by banks are no longer moving “in near lock step with the cash rate”.

The theme of a new normal was also touched on by AMP Capital Investors economist Shane Oliver, who said that while the RBA has cut the official cash rate back to its post-GFC record low of 3%, “overall policy settings are nowhere near as stimulatory as they were in mid-2009”.

“Bank lending rates are much higher, the Australian dollar is way higher and fiscal policy is being tightened not loosened."

In his latest economic note, Oliver said mining investment was fading rapidly and non-mining growth needed to pick up quickly.

“The trouble is that growth in other areas of the economy is soft. While the Reserve Bank has been cutting interest rates for just over a year the response has been subdued.”

Oliver pointed out that all key indicators – building approvals, credit growth, retail sales – “are currently well below the average level they attained this far into past easing cycles” and that further rate cuts were needed to achieve mortgage rates that will become “stimulatory”.

“Although the RBA has cut the official cash rate to its GFC low, because of bank funding issues bank lending rates are around 0.6-0.8 percentage points above their 2009 lows.

“The standard variable mortgage rate at around 6.42%, assuming banks pass on around 0.2% of the RBA’s latest 0.25% rate cut, is below its long term average of 7.25%.

“But normally rates need to fall well below their long-term average to be confident of stronger growth. And in an environment of household and business caution post GFC the neutral rate has likely fallen, probably to around 6.75% ,which is shown as the “new neutral” level," Oliver said.

"This would suggest that current mortgage rate levels are only just starting to become stimulatory.”

But HSBC chief economist Paul Bloxham disagreed.

"We expect that this could be the last in the easing phase of this cycle given China's economy is bottoming out, local rates are supporting the interest-rate sensitive sectors and inflation may have passed its trough, leaving the RBA will little further room to move," he said.