RBA on hold in November despite banks’ rate hikes: Westpac's Bill Evans

RBA on hold in November despite banks’ rate hikes: Westpac's Bill Evans
Bill EvansDecember 7, 2020

Last week we wrote about the potential impact on monetary policy of an independent move by Westpac to raise its variable mortgage rates by 0.2%.

We observed that the Reserve Bank has noted in the past that it moves its cash rate to target retail rates.

The issue was whether a move by one bank would trigger a response from the RBA.

We argued that it was too early to make such a prediction given that the extent of financial tightening was not known. A move by one bank was insufficient to make a significant impact on overall financial conditions.

Yesterday the CBA Group, which covers 25% of mortgages, raised their mortgage rates by 0.15%. Today the NAB (14.8%) moved by 0.17%. and ANZ (14.7%) moved by 0.18%.

Overall, those banks that have been subject to the increase in capital requirements, and are now raising their mortgage rates, cover around 77.5% of mortgages in the system. The rest is covered by the regional banks (16.9%) and non-bank lenders (5.5%).

However, only about 85% of mortgages are on variable rate terms. This means that the net effect across the economy of these changes to variable mortgage rates by the majors will be around 11bps.

When the RBA moves rates it can affect both mortgages and business loans. Mortgages represent around 60% of total loans in the system so this initiative by the banks roughly equates to a 6-8bp rate hike by the RBA that is fully passed on by all financial institutions to both mortgage and business borrowers (depending on the exact share of loans directly affected by an RBA move).

On this basis it seems unlikely that the RBA would move immediately to offset bank rate rises with a 0.25% rate cut.

However last week we noted the historical precedent of 2012 when the RBA cut by 0.5% in May following increases of only 0.10% in variable mortgage rates by the banks.

Points we made about that period were firstly that the RBA had a very strong easing bias at the time, giving clear guidance that “inflation outlook would provide scope for easier monetary policy”. Despite that bias there was an extended delay between the banks’ moves in February that year and the eventual RBA cut in May.

When it did finally make a cut it also revised down its growth forecasts for 2012 from 3.25% to 3.0% and for 2013 from 3.5% to 3.0%. The 2013 change was very significant, cutting the outlook from comfortably above trend to around trend.

So to recap: despite fully neutralising the banks’ move and delivering a cut over and above that and subsequent bank moves (the banks only passed on 0.35% of the RBA’s 0.50% cut by the RBA) the RBA still revised down its growth forecasts significantly. One can only imagine what the revision would have been without the rate cut.

This brings us to the conclusion that given the move by the banks tightens financial conditions by significantly less than 0.25%, a full 0.25% rate cut would result in a net easing in financial conditions (on the basis that banks pass on the full cut). Hence the case would need to be made that the RBA needs to provide a net easing of financial conditions to justify a rate cut in November.

There was nothing in the Board’s minutes from the October meeting to suggest that a net financial easing was going to be required in the near term. In fact the minutes indicated that the Board was a little more upbeat about the domestic outlook, in particular noting: “forward-looking indicators had generally been consistent with the unemployment rate being around its current level or possibly slightly lower in the months ahead”. Recall that six months ago the Board was forecasting the unemployment rate to continue to rise through to the first half of 2016.

However we must acknowledge that November has in the past been a very popular month for the Bank to move rates. That is because, like February, May and August it presents the Bank with the opportunity to review its forecasts.

A scenario that would see the Bank cutting rates in November would be associated with a significant downward revision in its growth forecasts for 2016. If that decision was based around the banks’ actions then it would mean that the expected tightening in financial conditions would be sufficient to lower the growth outlook.

Given the effective size of the tightening though it seems unlikely that this would be viewed as sufficient to sharply lower the growth outlook.

With the RBA currently forecasting growth in 2016 to be an above trend 3.0% it would be necessary for the Bank to be considering a below trend 2.5% for the 2016 view to trigger a rate cut in November.

That seems premature given that the key way in which the banks’ decisions would impact the economy would be through confidence. Even the cash flow effect is likely to be muted. For example, Westpac noted that 70% of its borrowers are ahead on repayments – the rate rise will mean that these borrowers will take a little longer to pay down their loans rather than take a cash flow ‘hit’.

Surely the RBA would need to see the confidence impact of the banks’ moves before it decided to cut rates and lower its growth forecasts. A clean measure of that response will not be available until the Westpac Melbourne Institute Index of Consumer Sentiment is released on November 11.

The minutes were also used to signal the RBA’s comfort with the decisions of the banks so far with the comment that: “members judged that there were signs that the response of the banks to supervisory measures implemented by APRA were helping to manage risks in the housing market”. 

While that statement is probably referring to the banks’ tightening in lending guidelines and increase in interest rates for investor loans (announced back in July) it could, arguably have been used as a way of signalling that it was also comfortable with the Westpac move given it was only targeted at the housing market which has been the area of ‘excess’ concerns for the RBA.

So we feel quite comfortable in ruling out a rate cut in November. A December move, triggered by a major slump in confidence, remains a possibility. But our core view that rates are on hold through 2015 and 2016 is much more at risk in the early months of 2016.

After all, markets have been pricing in a full 0.25% cut by March and a 50% chance of a second cut by June.

A slowdown in consumer spending associated with the banks’ tightening or adverse developments offshore are much more likely to be triggers for the sort of downward revision to growth that would be linked with a February rate cut.

The October minutes implied such concerns with a more downbeat assessment of the outlook for China; and a marked change in the assessment of the outlook for the Federal Funds rate, noting that some market participants did not expect a Fed hike for the foreseeable future.

That compared with the September minutes which commented that “a tightening of monetary policy in the United States could start at the September meeting of the Federal Open Market Committee”.

The heavy emphasis on global issues culminated in the minutes concluding: “information about economic and financial developments, both domestically and abroad, would continue to inform the Board’s assessment of the outlook”. [Westpac’s emphasis]

Conclusion

We see little chance of an RBA rate cut in November. December remains ‘live’ as it allows for the Bank to assess the impact of the moves by the banks on confidence.

A combination of a more lagged impact on spending from the banks’ moves and adverse global developments including an extended pause from the FOMC (meetings in December and January before the February meeting of the RBA) might trigger the cut which the market so confidently expects from the February meeting.

For our part, including our expectation of a Fed tightening in December, we retain our central view that rates will be on hold over the course of the remainder of 2015 and 2016. 

 

Bill Evans is chief economist of Westpac.

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