RBA is optimistic about the spillover effects of tightening in housing lending standards: Westpac's Matt Hassan

EXPERT OBSERVATION

As expected, the Reserve Bank Board decided to leave the cash rate at 1.5% at its June policy meeting.

The Governor’s decision statement also showed little substantive change although there were some notable shifts in the discussion around housing and labour markets.

A subsequent speech by the RBA Governor added more colour, indicating that while the economy was still moving in the right direction, the outlook for consumers, labour markets and wages growth remained uncertain and progress towards the Bank’s expected lift in incomes and inflation would be slow.

With labour market updates continuing to show job gains moderating and the economy’s ‘full employment’ unemployment rate likely to have moved lower, progress could be very slow indeed – more ‘glacial’ than ‘gradual’.

The key parts of the June decision statement were unchanged from May.

The closing paragraph was identical, retaining the line that “Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual.” The core narrative of the statement was also essentially unchanged: a strengthening global economy with financial conditions expansionary (notwithstanding recent events and some increase in short term rates); an Australian economy tracking towards growth a little above 3%; consumers a continuing source of uncertainty but indicators pointing to a gradual reduction in unemployment and the outlook pointing to a gradual pick-up in inflation.

Where there were changes, these tended to be mainly ‘housekeeping’ in nature, either incorporating recent developments, rolling commentary to reflect the local data calendar or simply the passage of time.

Where shifts went a little further was around housing and labour markets.

The housing slowdown in Sydney and Melbourne was noted, as per May. More significantly, the statement notes a slowdown in investor housing credit, retaining a line that “APRA’s supervisory measures and tighter credit standards have been helpful in containing the build-up of risk in household balance sheets” but adding that “while there may be some further tightening of lending standards, the average mortgage interest rate on outstanding loans is continuing to decline.”

Together this is a strong indication that, to the extent that we are seeing an additional tightening in lending standards weigh on housing markets, the Bank views this as part of an important ‘de-risking’ exercise that is likely to have few material spillover effects to the wider economy.

That looks to be an optimistic assessment in our view. Firstly, rates and conditions on the ‘marginal’ loan are more important for market conditions.

Secondly, the slight decline in the average mortgage rate ignores a likely rise in average repayments as borrowers shift from ‘interest only’ to ‘principal and interest’ loans.

And thirdly, the discussion ignores potential negative spillovers via confidence and wealth effects (see the ‘Aus consumer incomes, wealth and demand’ article in our latest monthly Market Outlook report for a more detailed discussion).

The Governor’s statement carried a little less conviction around the labour market, the unemployment rate described as “little changed at around 5½ per cent for much of the past year” compared to last month when it was described as having “declined over the last year but … been steady … for some months” with a comment contrasting the improving labour market with low wages growth cut back to simply observe “wages growth remains low”.

While we warn against ‘over-reading’ these sorts of language changes we note that the RBA’s official forecasts currently have only a modest decline in the unemployment rate – down 0.25% to 5.25% by mid 2020 – and that the ‘full employment’ level below which conditions would be expected to see wage inflation pick up is thought to be somewhat lower.

This more circumspect assessment of prospective labour market conditions showed through in a more recent speech from the Governor on June 13. This reiterated the Bank’s general view that the economy is moving in the right direction, noting the slightly stronger than expected March quarter GDP result.

The Governor also repeated the broad expectation that “the next move in interest rates will be up, not down”. However, that line was more heavily qualified, with particular respect to the focus of the speech: uncertainties around labour markets and wages. Many conditions need to be met before the Bank would contemplate a move: the economy would need to continue “moving in the right direction”; household incomes would need to be “growing more quickly than they are now”; labour market slack would need to be lessening; and the Bank would need to be reasonably confident that inflation is moving back towards target. Most of this would require wages growth faster than the 2% pace we are current experiencing.

The RBA is likely uneasy about the latest labour market data.

Official figures continue to show a loss of momentum in jobs growth with utilisation flattening at levels indicating significant slack. Private business surveys suggest hiring should hold up but the latest Westpac Consumer Sentiment survey showed a notable weakening in unemployment expectations.

On wages, growth may have troughed but evidence of a meaningful lift remains scant. Certainly, a return to 3% wage growth looks a long way off.

We continue to expect policy to be unchanged in 2018 and 2019 and suspect the Governor’s resolve will be sorely tested by a return to sub-par growth against a backdrop of little or no progress towards its labour market, wage and inflation goals. 

Matthew Hassan is senior economist with Westpac.