Move to cut is a sudden and significant shift from the RBA
The regulators are becoming nervous about the state of the economy. The Reserve Bank appears to be about to cut the cash rate and the Australian Prudential Regulation Authority (APRA) has acted to try to stimulate the flow of credit to the housing sector.
The prospect of the first reduction in the cash rate since August 2016 was raised by the RBA Governor, Philip Lowe, in a speech to the Economics Society of Australia on Tuesday where he effectively made the case for a 25 basis point cut to the cash rate when the RBA board meetings in a fortnight’s time.
A reduction in the cash rate, now 1.5 per cent, has been widely expected as the economy has slowed and inflation has remained a negligible levels. A tick up in the unemployment rate in April may have been the final piece of evidence the RBA needed to decide it was time to move.
In fact, the bond market has been pricing in two 25 basis point cuts this year as it became clearer that a mix of adverse influences, both specific to the Australia and in the wider external environment, were slowing growth.
Weak household consumption growth and a threatening global environment as China’s economy, already slowing, is impacted by the trade war with the US are the more obvious factors influencing the RBA’s thinking.
It’s been a significant and rapid shift. Last year the bank’s bias was towards lifting the cash rate but, as the economy slowed, that moved to a neutral bias early this year. Now Lowe says that the bank’s board will "consider the case for lower interest rates" at next month’s board meeting.
It appears near-certain that its judgment will be that it should lower the rate again, to a new historic low. A lower cash rate, it should be said, isn’t good news. Central banks don’t cut their policy rates when times are good; they lower them because they are concerned their economies are faltering.
Whether a cash rate of 1.25 per cent will have any more of an impact than a cash rate of 1.5 per cent is an open question, but the fact that Lowe would canvass the prospect so openly is a sign of the RBA’s unease.
APRA eases path for borrowers
His speech coincided with APRA’s earlier announcement It is planning to revise the guidance on the serviceability assessments it directs banks to make on mortgage loan applications.
A lower cash rate, it should be said, isn’t good news. Central banks don’t cut their policy rates when times are good.
At present APRA insists that lenders use a minimum interest rate of at least 7 per cent, or a two per cent buffer over the rate they are charging, to assess borrowers’ ability to service their loans. In practice most lenders add a further 25 basis point margin to those benchmarks.
With the rates for new mortgage lending now below four per cent, APRA has decided the buffers are too big. It will now allow the lenders to set their own minimum rate floors, which ought to mean an increase in borrowing capacity for home loan customers.
The minimum interest floor and buffer were introduced in 2014 as APRA and the RBA tried to douse what was then a raging housing market.
The "macro-prudential" measures APRA implemented along with the chilling effect of the financial services royal commission and its examination of "responsible lending" have crimped the availability of home loans.
Growth in mortgage lending has slowed to low single-digit levels and provided the backdrop for the plunge in house prices with the flow-on effects to household confidence and spending.
APRA’s decision, coupled with a RBA rate cut, would make more housing credit available to individual borrowers at a lower cost.
There is a proviso. The major banks, experiencing margin squeezes and carrying the vast remediation costs associated largely with the misdeeds of their wealth management businesses, would need to allow borrowers to borrow more and also pass the benefit of the rate cut on.
The RBA’s likely move next month will have an unusual backdrop. Employment growth remains strong and unemployment remains, at just over five per cent, low by historical standards. The inflation rate, however, also remains stubbornly and unusually low.
It used to be the norm that unemployment rate around five per cent would generate increased inflation but the coincidence of falling unemployment and ultra-low inflation is a post-crisis phenomenon, and puzzle, throughout the developed world.
Technology, demographics and globalisation have been put forward, by Lowe and his peers at other central banks, as possible strands to the explanation for the novel conditions.
Lowe now believes, given those settings, that the Australian economy can support even lower unemployment without generating concern about inflation.
If the rate doesn’t move lower with the current policy settings, he said, the options included extra fiscal support, including infrastructure spending, and policies that supported firms expanding and investing.
And, of course, those options include monetary policy, the one lever the RBA can – and now seems certain to – pull.