RBA’s Weak Dovish Bias Because Rate Cuts Working More Than Expected

Last week, the Reserve Bank of Australia signalled a very weak dovish bias that was as good as hold for longer, to the surprise of many.

But what is more surprising is the change in bias was driven by RBA’s observation that monetary policy is doing more that what it expected.

In fact, both the cuts in the cash rate last year and the lower cash rate have been so effective that in a short span of time, the RBA’s thinking has shifted from “does the economy need more monetary stimulus?” to “is the economy in danger of getting too much monetary stimulus?”

In short, the RBA’s worry is whether too much of a good thing now would be bad in the medium to long run.

This risk from doing too much has meant the RBA is now pursuing monetary policy for the medium-term, and for the first time it has publicly talked about macro stability.

INTEREST RATE CUTS MAIN DRIVER

It was in late November that Governor Phillip Lowe said the rise in housing prices since the three rate cuts last year was not “solely to our handiwork.” There were things like the re-election of the coalition government, easing of prudential requirements, supply-demand balance that were going on other than interest rates, he said.

Lowe also said the RBA was not particularly worried about the rise in house prices and would be worried if credit growth picked up materially in response to high housing prices.

“If credit growth were to pick up materially from here and lending standards were to weaken, that would be something that would be concerning us, but that’s not the situation we’re in.”

Fast forward two months, at the Parliamentary testimony on February 7, Lowe’s views on housing prices changed completely.

He admitted that the cuts in interest rates has had a noticeable effect on housing prices, and this was contrary to what the RBA had expected.

“Six months ago, I did not see interest rates as the main thing that were driving housing prices,” Lowe said. The reference to six months was to the Parliamentary testimony prior to that. If that was not the case, Lowe could have well said that even two months ago, he did not see interest rates as the main driver for rising housing prices.

FOCUS ON OWNER-OCCUPIERS, HENCE MEDIUM-TERM MACRO-STABILITY

Housing prices have risen noticeably in recent months, with Sydney and Melbourne leading the gains according to data from CoreLogic. In the quarter to January, national housing values rose by 3.7%, combined capitals rose 4.2%;and Sydney and Melbourne values rose by 5.6% and 4.9% respectively.

Along with the rise in housing prices, there has been an increase in housing loan commitments.

But what is more interesting is that this time, the increase has been driven by owner-occupiers. Data published by the Australian Bureau of Statistics Tuesday showed, owner-occupier housing loan commitments rose 5.1% in December, the fastest pace since August 2015

The RBA also noted that owner-occupier housing credit growth was around 5.5% on the six-month annualized basis in December, up from 4.5% in mid-2019.

In the past, the RBA was more concerned when rise in housing loans and prices were driven by investors because the additional speculative demand from them had the potential to amplify property price cycles, and cause a risk to the macroeconomy, and to financial stability.

Currently, there has been no concern raised about investor activity and there has been no report of loosening in lending standards.

But there has been strong pick up in borrowing by housing owner-occupiers. And that borrowing has pushed up housing prices.

The RBA’s worry is that further cuts could encourage more borrowing just like the last three rate cuts have done. This borrowing is being done at very low interest rates by owner-occupiers.

The RBA is worried that any problem from here would leave households very vulnerable and its impact would straightaway be felt by the economy via consumption spending.

There is no financial stability worry at this stage. It is all about medium-term macro stability. And it’s driven by low rates and owner-occupier borrowing amid rising housing prices.