RBA Minutes Ultra Bullish

The RBA released their minutes today, and it continues the uber-positive story.  Pity it’s so myopic.

International Economic Conditions

Members commenced their discussion of the global economy by noting that growth in Australia’s major trading partners had been robust in 2018. Growth was expected to ease a little over the subsequent two years, but to remain above potential in 2019. Although there had been little change to the Bank’s outlook for trading partner growth over recent months, the latest forecasts had incorporated a small negative effect from recent tariff changes on growth in a number of economies, including the United States and some east Asian economies. Members discussed the risks to the global outlook from a further escalation in trade tensions and considered the implications for the Australian economy of a scenario in which wages and inflation in the United States pick up by more than expected, given the strength of the US economy.

Growth in the major advanced economies had remained above potential in 2018. Growth in the United States had been strong, supported by the sizeable fiscal stimulus. While US manufacturers had raised concerns about the effects of rising input costs and their competitiveness, business investment intentions had remained strong. Unemployment rates had declined further in the major advanced economies and wages growth had picked up. In the United States, the increase in wages growth had been boosted by workers changing jobs, but recently workers had also been receiving higher wage increases without changing employers. Members observed that inflation in the major advanced economies had increased as a result of higher oil prices and wages growth. However, core inflation had remained low and little changed in some advanced economies, notably Japan and the euro area, but was close to target in others, including the United States.

Growth in China had moderated a little further in the September quarter, following the tightening of financial conditions in late 2017 and early 2018. Although activity in the Chinese services sector had been resilient, conditions had remained weak in the industrial sector and public investment had declined. In response, the Chinese authorities had implemented targeted monetary and fiscal policies to support growth, while maintaining their commitment to containing risks in the financial system. The adverse effect on the Chinese economy from higher tariffs was likely to have been partly offset by policy measures that had been introduced to support affected trading firms. The depreciation of the renminbi over 2018 had also provided support to the economy overall. Elsewhere in Asia, indicators suggested that growth had eased a little recently. The fact that this easing had been most pronounced in growth in exports and industrial production suggested it may have been affected by US–China trade tensions, given the integration of east Asian economies in global manufacturing supply chains.

Commodity prices, in particular those for bulk commodities, had held up by more than had been expected over the previous year. In part, this reflected a number of unforeseen disruptions to supply, particularly for coking coal. Members noted that, in addition, global steel demand had been stronger than anticipated. Oil prices had also risen, which had increased Australia’s terms of trade. Although Australia is a net importer of oil, Australian exports of liquefied natural gas (LNG) and other oil-related products – the prices of which are linked to oil prices – are larger, following a sustained period of strong growth. Along with a higher starting point as a result of commodity prices having held up, the forecast for Australia’s terms of trade had been revised higher for the next few years owing to a reassessment of the expected strength in global demand for commodities, particularly from China and India.

Domestic Economic Conditions

Members noted that the recent run of economic data suggested that growth in the Australian economy had been higher over the year to the June quarter than earlier forecast, and above estimates of potential growth. Labour market conditions had remained strong and other available indicators pointed to further solid GDP growth in the September quarter. At the same time, inflation in the September quarter had slowed as expected, partly as a result of a large policy-induced decline in childcare prices.

GDP growth was expected to be around 3½ per cent on average over 2018 and 2019. Members noted that growth would be supported by accommodative monetary policy, above-trend growth in Australia’s major trading partners and a stronger profile for the terms of trade. Year-ended GDP growth was expected to ease to around 3 per cent towards the end of 2020 because LNG exports were expected to reach capacity production levels by the end of 2019.

Consumption had continued to grow by around 3 per cent in year-ended terms, despite ongoing low growth in household income. Growth in retail sales had been volatile on a quarterly basis, although in year-ended terms growth had been fairly steady at a relatively modest rate. Conditions had continued to differ across states; retail sales had been relatively strong in Victoria but had declined in Western Australia. Members noted that the strong pace of growth in retail spending online in recent years could be one factor contributing to subdued conditions in retail rental markets. Year-ended growth in household consumption was expected to remain around 3 per cent over the following few years. Growth in household disposable income was forecast to increase to a similar rate.

Although residential building approvals had fallen in the September quarter and liaison indicated that pre-sales had become harder to obtain, the large pipeline of work yet to be done was expected to support dwelling investment at a high level over the following year or two. Members noted that population growth was expected to remain fairly strong over the following few years, and that this would provide some support to housing demand. However, there had been reports that bank financing of large development projects had become more difficult, particularly in areas where there had already been substantial development.

Members noted that established housing prices had fallen further in Sydney and Melbourne. After rising by more than apartment prices in preceding years, house prices had fallen by more than apartment prices since 2017. Conditions in the established housing market had been stable in most other cities, although housing prices had declined a little further in Perth in recent months. Rental vacancies had increased in Sydney, consistent with the additions to the stock of housing over the past year, and rent inflation had remained low across the country.

Members observed that business investment had been stronger than forecast a year earlier. The recent strength in non-mining business investment was expected to continue and to make a significant contribution to output growth over the forecast period. Private non-residential construction was expected to be supported by above-average business conditions and the significant pipeline of non-residential construction work that had been approved. Expenditure on machinery and equipment was also expected to rise over the forecast period. Members noted that mining investment had not fallen by as much as expected over the previous year, largely reflecting additional spending on the remaining LNG projects under construction. The trough in mining investment was still expected to occur in late 2018 or early 2019.

Exports had continued to make a significant contribution to growth in output over the preceding year. Resource exports had increased further, mainly because production of LNG had continued to ramp up. Service and manufacturing exports had been supported by strong global growth and the depreciation of the Australian dollar over 2018. The persistent drought conditions in New South Wales and bordering regions in Queensland and Victoria had led to a short-term boost to rural exports because livestock slaughter rates had increased and some grain crops had been harvested early to take advantage of higher feed prices. However, the medium-term outlook for farm sector production had been revised lower.

Labour market conditions had been stronger than expected. Members noted that much of the employment growth had been in full-time employment and that the participation rate had remained at a high level. The unemployment rate had declined to 5 per cent in September. Unemployment rates in most states had trended lower in recent months and were particularly low in New South Wales and Victoria. The unemployment rate was now expected to decline gradually to around 4¾ per cent by mid 2020, although members noted that some leading indicators of labour demand suggested there could be a more pronounced decline in the unemployment rate in the near term.

The improved labour market outlook had led to a modest upward revision to the outlook for wages growth. The recent increases in award and minimum wages were expected to have provided a small boost to wages growth in the September quarter. Members discussed the wage increases associated with recent enterprise bargaining agreements and uncertainties around the extent to which these and ongoing negotiations might flow through to overall wages growth. Members noted that average real earnings had not increased for six years and that wages growth was a key uncertainty for both future consumption growth and inflation.

Year-ended inflation had remained low in the September quarter. CPI inflation was 1.9 per cent over the year to the September quarter and had been around 2 per cent since early 2017. Underlying inflation was a little below ½ per cent in the September quarter and around 1¾ per cent over the year. As expected, the quarterly outcome incorporated a large decline in administered prices, reflecting a sharp decline in childcare prices owing to changes in government subsidies and a moderation in utilities inflation. The noticeable step-down in administered price inflation from earlier years was expected to be temporary, although members noted that future outcomes depended on possible government initiatives to reduce cost-of-living pressures. Inflation in the cost of new housing and rents had also been subdued in the September quarter. Inflation was still forecast to increase gradually over time as spare capacity in the economy declines. The brighter outlook for economic activity and the labour market, compared with three months earlier, had led to a small upward revision to the inflation forecasts.

Financial Markets

Members commenced their discussion of financial market developments by noting that financial conditions in the advanced economies remained accommodative, although they had tightened somewhat recently.

In October, equity prices had declined sharply across the major markets. Analysts had attributed the fall to a range of factors, including higher bond yields, concerns that the pace of earnings growth would decline given trade tensions and building cost pressures, and elevated valuations (particularly in the United States). Members noted, however, that recent corporate earnings, especially in the United States, had grown strongly and had mostly been above forecasts.

Members observed that there had generally been little spillover from equity markets to other financial markets. Money market and corporate bond spreads had increased a little but remained relatively low. Term premia for sovereign debt and exchange rate volatility also remained low in the major markets. Members noted that the leveraged loan market had grown rapidly, particularly in the United States, and corporate funding had increasingly shifted to the securities markets rather than bank finance.

Monetary policy in the major economies remained accommodative. Members noted that financial market pricing continued to imply that policy settings of central banks are on divergent paths, reflecting differences in spare capacity and/or the inflation outlook across economies. In the United States and Canada, markets were pricing in a further tightening in monetary policy over the coming year. Financial market pricing continued to imply a lower path for the US federal funds rate than suggested by the median projection of Federal Open Market Committee members. Market pricing implied a smaller increase in policy rates over the coming year in the United Kingdom, Norway and Sweden, with rates expected to remain very low in these economies. By contrast, market pricing was consistent with policy rates remaining steady over the following year in Australia and New Zealand, where policy rates had not been lowered to the extent they had in some other economies. In Japan, the euro area and Switzerland, market pricing remained consistent with maintenance of the highly accommodative monetary policy settings in these economies.

Members observed that the divergent monetary policy paths had been reflected in long-term government bond yields, which had increased in the United States and Canada over the prior year, but had been broadly unchanged in other major markets and Australia. Members noted that long-term government bond yields in Australia were now clearly below those in the United States as a result. Members also noted that long-term government bond yields remained low by historical standards in the major markets, with inflation expectations contained and term premia particularly low.

In Italy, the spread of Italian government bond yields over German Bunds had risen further in October, following the rejection by the European Commission of the Italian Government’s draft budget. However, Italian yield spreads remained below the levels seen during the European debt crisis in 2012 and there had been limited spillovers to other European bond markets. Nevertheless, ongoing concerns about Italian fiscal policy settings were likely to remain a focus for financial market participants.

Financial conditions in emerging markets had stabilised recently, as earlier political and macro-financial concerns in Turkey, Argentina and Brazil had eased somewhat. After depreciating sharply since the beginning of 2018, these economies’ exchange rates had appreciated over the preceding couple of months. This followed some corrective policy responses and an easing in perceived political risk. Exchange rate volatility had also declined from its recent peak across emerging market economies more broadly. However, members noted that there remained a risk that capital outflows from emerging markets could broaden and intensify, prompting a more significant tightening of financial conditions.

In China, the authorities had implemented further targeted measures to ease financial conditions in response to slower growth, while balancing their commitment to containing risks in the financial system. In October, banks’ reserve requirement ratios were cut by another 1 percentage point, following earlier measures to ensure ample bank liquidity. The decline in Chinese share prices over 2018 had also recently prompted the authorities to announce measures to support the equity market. The renminbi exchange rate had depreciated over 2018 in response to concerns about trade protection and the outlook for growth, as well as the policy measures targeted at easing financial conditions. However, unlike the 2015 depreciation episode, there had been few signs of large-scale capital outflows or direct foreign exchange intervention by the authorities.

The Australian dollar had depreciated a little over the course of 2018, but remained in the fairly narrow range observed over recent years on a trade-weighted basis. Members observed that this had reflected offsetting effects on the exchange rate from higher commodity prices, on the one hand, and the decline in Australian bond yields relative to those in other major markets, on the other hand.

Members noted that Australian banks’ funding costs remained a little higher than in 2017, reflecting the increase in short-term money market rates over the first half of 2018. More recently, the spread of bank bill swap rates relative to overnight indexed swaps (OIS) had declined marginally over the preceding month, while the spread of US LIBOR to OIS had increased. Information from liaison suggested that there had been little change in domestic money market conditions in recent months. The modest increase in funding costs earlier in the year had been passed on by most lenders to existing borrowers with variable-rate business and housing loans.

The pace of overall credit growth had been maintained in recent months, as slowing housing credit growth had been offset by a pick-up in business credit growth. The easing in growth in housing credit had reflected a slowing in growth in lending by the major banks. By contrast, growth in housing lending by other authorised deposit-taking institutions (ADIs) had picked up. Housing lending by non-ADIs had continued to grow strongly, although these institutions’ share of total housing credit remained small. Members noted that the easing in housing credit growth had been accounted for largely by slower growth in credit extended to investors, which was now close to zero. Growth in lending to owner-occupiers had eased more gradually and remained around 6½ per cent in six-month-ended annualised terms.

Members noted that the easing in housing credit growth was likely to reflect both tighter lending conditions and some weakening in demand. Stricter lending criteria had reduced maximum loan amounts. At the same time, however, interest rates offered on new loans remained lower than interest rates on outstanding loans, consistent with banks continuing to compete for new borrowers.

Financial market pricing implied that the cash rate was expected to remain unchanged for a considerable period.

Considerations for Monetary Policy

As part of a regular annual review process, members considered how the domestic economy had evolved over the preceding year relative to the Bank’s forecasts of a year earlier. Members noted that the magnitude of forecast errors for key variables, including GDP growth, the unemployment rate and inflation, had been smaller than the historical averages. Overall, GDP growth had been higher than expected at the time of the November 2017 Statement on Monetary Policy. While most components of GDP had turned out to be a little stronger than expected, the main source of the upward surprise had been business investment, owing to unexpected strength in both mining and non-mining investment. In addition, the terms of trade had been higher than expected over the previous year and the Australian dollar had depreciated. Consistent with these developments, labour market outcomes had also been stronger than expected a year earlier and more progress had been made in reducing unemployment than expected. Despite this, wages growth and underlying inflation had evolved largely as expected. Overall, members noted that the economic outcomes over the preceding year had been consistent with the economy continuing on its forecast trajectory of gradually declining spare capacity, with a correspondingly gradual increase in wages growth and inflation.

In the context of the annual review of the forecasts, members also reviewed arguments that had been advanced by various commentators during the preceding year for an increase or decrease in the cash rate. Some of these arguments relied on different assessments than had been made by the Board in relation to the benefits of seeking faster progress on the Bank’s inflation and unemployment rate objectives, versus the risks to longer-term sustainable growth from further increases in household debt. Other arguments for a change in the cash rate relied on an alternative assessment about the economic outlook and/or the risks around the outlook. Arguments in favour of an increase in the cash rate included that the economy had more momentum than assessed by the Bank; financial stability risks from high levels of household debt required higher interest rates; and a higher cash rate would create room to cut the cash rate in future in response to an adverse event. The prime argument in favour of a decrease in the cash rate was that easier monetary policy could lead to faster progress in achieving the Bank’s monetary policy objectives.

Members discussed how different scenarios could affect the monetary policy decision, noting that the appropriate policy response would depend on the specifics of the situation, including the underlying factors driving economic developments. For example, in the event of a marked change in the strength of the global economy, the effect on the Australian economy – and thus the appropriate monetary policy response – would depend on any associated move in the exchange rate of the Australian dollar. Members also discussed various scenarios related to the labour market and household expenditure.

Turning to the current month’s decision, members noted that the global economy had continued to grow strongly and global financial conditions remained accommodative, although conditions had tightened somewhat recently. Most advanced economies were growing at above-trend rates and their labour markets had continued to tighten. This had led to a noticeable pick-up in wages growth. In some economies, most notably the United States, inflationary pressures were building. Growth in China had slowed a little and the authorities had responded to weakness in some sectors of the economy with targeted policy measures, while continuing to pay close attention to risks in the financial sector. Members noted that the direction of international trade policy continued to be a significant risk to the global outlook.

Against the background of rising global inflationary pressures, a few central banks, including the US Federal Reserve, were expected to continue to reduce the degree of monetary policy accommodation gradually. Changes in the expected paths of monetary policy over the preceding year had been reflected in changes to financial market pricing, most notably a broad-based appreciation of the US dollar. The associated modest depreciation of the Australian dollar over 2018 was likely to have been helpful for domestic economic growth.

Members noted that economic conditions in the Australian economy had continued to improve and had been a little stronger than expected. The outlook for growth had been revised a little higher, mainly as a result of upward revisions to history and recent strong data. Year-ended GDP growth was expected to remain above 3 per cent over 2019, before slowing to around 3 per cent in 2020. Members observed that the outlook for consumption continued to be a source of uncertainty in an environment of slow growth in household incomes, high debt levels and easing conditions in housing markets in some parts of the country. These conditions warranted close monitoring. At the same time, investment had been stronger than expected over the previous year and business conditions were positive; if the recent momentum were to be sustained, business investment could turn out to be stronger than currently expected. However, the drought had led to difficult conditions in parts of the farm sector.

Conditions in the labour market had also been stronger than expected and forward-looking indicators of labour demand continued to point to ongoing strength in the near term. As a result, the forecast for the unemployment rate had been revised lower and the forecast for wages growth had been revised slightly higher. Members noted that there continued to be uncertainty about the degree of spare capacity in the labour market and the extent and speed of any pick-up in wages growth relative to the gradual increase incorporated in the latest forecasts. They acknowledged that a gradual increase in wages growth was likely to be necessary for inflation to be sustainably within the target range.

Underlying inflation had remained low and stable at around 1¾ per cent, consistent with the previous forecasts, despite stronger-than-expected economic activity. Although there was a possibility of further declines in administered prices in the year ahead, underlying inflation was expected to pick up gradually over the forecast period, to be a little above 2¼ per cent in 2020.

Conditions in the Sydney and Melbourne housing markets had continued to ease, following significant growth over preceding years. Rent inflation had remained low. Housing credit growth had declined, particularly for investors, but had continued to be higher than growth in household income. Credit conditions were tighter than they had been for some time, partly because lending standards had been tightened following the introduction of supervisory measures to help contain the build-up of risk in household balance sheets. At the same time, home lending rates had remained low and there was strong competition for borrowers of high credit quality.

Taking account of the available information on current economic and financial conditions, as well as the latest forecasts, members assessed that the current stance of monetary policy would continue to support economic growth and allow for further gradual progress to be made in reducing the unemployment rate and returning inflation towards the midpoint of the target. In these circumstances, members continued to agree that the next move in the cash rate was more likely to be an increase than a decrease, but that there was no strong case for a near-term adjustment in monetary policy. Rather, members assessed that it would be appropriate to hold the cash rate steady and for the Bank to be a source of stability and confidence while this progress unfolds. Members judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

The Decision

The Board decided to leave the cash rate unchanged at 1.5 per cent.

IMF On The Australian Economy

The IMF has released their Concluding Statement of the 2018 Article IV Consultation Mission.  And, well, it gives a relatively clean bill of health, whilst talking of risks in the housing sector, a need for more financial risk oversight and suggests that supply side issues need to be addressed to ease affordability. In other words they are following the RBA mantra, no household debt problem here and APRA’s bank capital is unquestionably strong! We will see.

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

  • Australia’s recent strong growth is expected to continue in the near term, further reducing slack in the economy and leading the way to gradual upward pressure on wages and prices.
  • Despite recent strong growth and declining unemployment, it is not yet the time to withdraw macroeconomic policy support given remaining slack.
  • While Australia benefits from a robust regulatory framework, further bolstering of financial sector systemic risk oversight and financial supervision would be helpful.
  • The cooling of the housing market is welcome and can be weathered in a strong economy. Housing supply reforms will be critical to restoring housing affordability.

Australia is now on the final leg of its rebalancing and adjustment after the end of the commodity price and mining investment boom. Growth has picked up strongly to well above 3 percent in 2018, driven by business investment and private consumption, while the recent rebound in the terms of trade has been sustained. The strong economic momentum has resulted in further improvements in labor market conditions. Nonetheless, wage growth has remained weak, suggesting some remaining labor market slack. The disinflationary effects from continued strong retail competition still weigh on core inflation, while one-off declines in some administered prices have temporarily lowered headline inflation. After rising by 70 percent in the past ten years at the national level and by roughly 100 percent in Sydney and 90 percent in Melbourne, house prices have moderated recently in a cooling housing market. Several factors have contributed to the cooling, including tightening credit supply, increasing housing supply coming to the market, and easing foreign demand. Market dynamics have adjusted in the process.

The economy’s strong growth momentum is expected to continue in the near term. Private consumption growth is anticipated to remain buoyant, supported by strong employment gains. The rebound in non-mining private business investment and further growth in public investment is envisaged to offset a softening in dwelling investment. With growth above potential, the output gap will close and labor market slack will erode, eventually leading to upward pressure on wages and prices. Macroeconomic policies will then adjust, and growth is expected to moderate to that of potential in the medium term.

The balance of risks to economic growth is tilted to the downside with a less favorable global risk picture. A weaker-than-expected near-term outlook in China coupled with further rising global protectionism and trade tensions could delay full closure of the output gap, although there are also upside risks to the terms of trade in the near term. A sharp tightening of global financial conditions could spill over into domestic financial markets, raising funding costs and lowering disposable income of debtors, with the impact also depending on the response of the Australian dollar. On the domestic side, a stronger pickup in the non-mining business sector, larger spillovers from public infrastructure investment, and the Australian dollar depreciation in real effective terms over the past year could boost near-term growth more than projected. Domestic demand may equally turn out weaker if wage growth remained subdued or investment spillovers were smaller.

The housing market downturn is another source of risk. Under the baseline outlook, the correction remains orderly, reflecting a combination of continued strong underlying demand for housing in the context of population growth and no significant oversupply, the presence of other strong growth drivers, and a resilient banking sector continuing to extend credit to support economic growth. Nevertheless, other negative risk developments, as outlined above, could amplify the correction and lower domestic demand.

Notwithstanding recent strong growth, it is not yet the time to withdraw macroeconomic policy support given remaining slack. With the cash rate at 1.5 percent, monetary policy remains appropriately accommodative. Normalization should remain conditional on evidence of more substantive upward pressures on wages and prices, as inflation is still below the target range. The broadly neutral fiscal policy stance is welcome. With more limited conventional monetary policy space, a fiscal stimulus would likely need to be part of an effective overall policy response if major downside risks materialized.

With the economy expected to return to full employment, the government’s medium-term fiscal strategy appropriately aims to reach budget balance by FY2019/20 and run budget surpluses thereafter. Under the baseline outlook, this fiscal path would still be consistent with the Commonwealth and state governments continuing to run ambitious infrastructure investment programs and structural reforms in support of higher growth. The principle of running budget surpluses in good times has been a core element of fiscal strategies required under Australia’s fiscal framework, which has helped in preserving fiscal discipline and substantial fiscal space, notwithstanding shocks with protracted effects. Given the fiscal space, Australia remains in a position to respond flexibly in case large downside risks should materialize. A role for medium-term debt anchors as a complementary element in fiscal strategies might also be considered.

The Australian banks are well capitalized and profitable. Following the requirement for capital to be unquestionably strong, banks’ capital levels are high in relation to international comparators.

Managing financial vulnerabilities and risks from high household debt requires macroprudential policy to hold the course. Earlier prudential intervention by the Australian Prudential Regulation Authority has lowered the risks to financial stability from higher-risk household debt and other vulnerabilities, in particular reducing the share of investor and interest-only borrowing. This has supported the strengthening of lending standards and the increase in bank resilience. Nevertheless, heightened systemic risks remain from high household debt levels and banks’ concentrated exposure to mortgage lending. Given prospects of interest rates remaining low for some time, macroprudential policy should focus on expanding the available toolkit by addressing any data, legal and regulatory requirements and thus enhancing readiness to implement such measures if and when needed.

The Australian authorities have developed a robust regulatory framework, but further reinforcement in two broad domains would be beneficial.

  • The systemic risk oversight of the financial sector could be strengthened. The IMF’s Financial Sector Assessment Program (FSAP) recommends buttressing the financial stability framework by strengthening the transparency of the work of the Council of Financial Regulators on the identification of systemic risks and actions taken to mitigate them. Improving the granularity and consistency of data collection and provision would support the analysis of systemic risks and formulation of policy.
  • Financial supervision and financial crisis management arrangements should be further bolstered. The FSAP’s specific recommendations include increasing the independence and budgetary autonomy of the regulatory agencies, strengthening the supervisory approach, particularly in the areas of governance, risk management, and conduct, and enhancing the stress testing framework for solvency, liquidity, and contagion risks. The FSAP also recommends strengthening the integration of systemic risk analysis and stress testing into supervisory processes, completing the resolution policy framework and expediting the development of bank-specific resolution plans. Recent announcements of additional funding for the regulatory agencies are welcome.

The cooling of the housing market is welcome and contributes to improving housing affordability. In the absence of a sharp rise in unemployment, interest rates, or housing inventories, an orderly correction in housing prices will help contain macro-financial vulnerabilities. Pressures on housing affordability, which is critical for growth to remain inclusive, will be relieved in the process.

Housing supply reforms will be critical to restoring housing affordability, and progress has been ongoing. Planning, zoning, and other reforms affect supply and prices only with long lags, and underlying demand for housing is expected to remain robust. Housing supply reforms should, therefore, not be delayed because of the housing market correction. Progress has been made through better integration of policies across government levels through “city deals,” including for western Sydney and its new airport, and for Darwin. Some states should still take the opportunity for further consolidation in planning and zoning regulation. These policy efforts should be complemented by broader tax reforms that also address housing and land use. Such reforms would strengthen the effectiveness of supply-side measures and reduce structural incentives for leveraged investment by households, including in residential real estate.

There is scope to expand infrastructure spending further to stimulate productivity. Australia is a fast-growing economy supported by high population growth, and its infrastructure needs are also increasing rapidly. Even with the recent increase in the infrastructure spending envelope, an infrastructure gap will remain. Reducing the gap further would help in lowering congestion and increase the economy’s potential in the long term, as would improving the effective use of existing infrastructure. The improvements that have been made in the institutional framework for infrastructure planning and assessment support policy efforts in this respect.

Recent policy decisions should help encourage innovation. A reform of the research and development (R&D) tax credit system is with Parliament, aiming for a more efficient and targeted use of the tax credit. It will be complemented by higher funding for research infrastructure. The recommendations of the science agenda laid out in Australia 2030: Prosperity through Innovation are constructive and should be implemented, as envisaged in the government’s response to the report.

Energy policy should further reduce uncertainty for investment decisions. Governments have already made substantial progress on pricing and reliability issues. The clarification in due course of policies to achieve Australia’s greenhouse gas emissions target commitments will also help reduce uncertainty.

Broad tax reform to support productivity and inclusive growth would be desirable. The share of direct taxes in Australia’s federal tax revenue is higher than the average of OECD economies, and shifting from direct to indirect taxes would lower tax distortions and enhance productivity. The Commonwealth government has to date lowered company tax rates for SMEs and introduced personal income tax cuts. These reforms should be combined with reforms to raise the GST revenue, lower the company tax rate more broadly, and reduce tax concessions. To offset the regressive element from higher GST revenue, an income tax-based rebate scheme to reduce the negative impact on lower income groups should be considered.

Australia’s continued efforts toward further trade liberalization and promoting the global multilateral trading system are welcome. This includes supporting new WTO agreements and modernization efforts. The formal ratification of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (also known as CPTPP or TPP-11), which replaces the Trans-Pacific Partnership, sends a positive signal in a time of increasing global trade tensions

CBA Had Suggested Broker Fee For Service

Commonwealth Bank’s CEO Matt Comyn spent yesterday (19 November) in front of counsel assisting Rowena Orr QC, discussing many of the issues which came about in commissioner Kenneth Hayne’s interim report, via Australian Broker.

During the hearing Comyn said he supported a flat fee for service remuneration model for brokers and regulation change over trail commission.

He also said he had been in talks as far back as April 2017 considering making the change for CBA, but in the week before feared a “first mover disadvantage” if no one else made the same move.

Comyn was quizzed on research he had put forward to both the Sedgewick review and ASIC’s review into broker remuneration and said that brokers were “sensitive to where the commission structure is set”.

This was due to the findings of one report which suggested that broker flows to lenders increased with higher broker commissions. According to this evidence, one lender gained a 5.9% market share when they offered a limited time commission increase and then lost 5.1% when it stopped.

Orr went on to ask Comyn about emails sent to former CEO Ian Narev, where Comyn had suggested a fee for service model as seen in the Netherlands.

He said it would work the same in Australia, where to level the playing field and “preserve” mortgage brokers, banks would also need to offer a fee to customers for the execution of a mortgage.

He said, “I think it would put a material disadvantage to the brokers if customers paid a broker but they didn’t have to pay a similar amount to a financial institution. I think that would create a distortion.”

Comyn said CBA had been looking at moving to a flat fee model back in April 2017, but was concerned other institutions would not follow.

He said, “We were struggling or grappling with how to implement, and I’m sure we will return to it, we felt there was a genuine first mover disadvantage.

“We didn’t think it would be replicated, absent regulatory intervention. Therefore, we didn’t think we would improve customer outcomes because, effectively, no one else would change their model. We would just originate fewer loans through that channel.”

Confirming Comyn’s stance on the broker remuneration model Orr said, “So you would like to change to a flat fee model?”

Comyn said, “I can certainly see advantages in that model, yes. I would add that that view would not be supported by other participants in the industry but my personal…”

Interrupting, Orr said, “I am asking you about your view, Mr Comyn?”

Comyn replied, “Yes, that is my view.”

Orr said, “You would prefer to move to that sort of model?”

To which Comyn said, “Yes, I would.”

Looking specifically at trail commission, Orr asked Comyn about the services brokers continue to provide after the loan is complete if that was the argument for trail.

Commissioner Hayen interjected and asked if there were any ongoing services supplied by a mortgage broker.

Comyn replied, “I think they would be limited, Commissioner.”

When asked if that meant “limited or none”, Comyn said, “Much closer to none”.

When Orr asked Comyn if he thought trail commissions needed regulatory change, he said “Yes”.

The emails to Narev also discussed how much revenue the broker would lose on an average loan. The broker revenue on an average loan at the time of the email written was $6627 and would be expected to reduce to $2310, in line with the “acceptable band for the price of financial advice”.

How Persistent Is Financial Distress?

From The St. Louis Fed.

Interesting research from the US, which shows that households who get into financial difficulty may make up a minority of all households, but they tend to stay in this state for an extended period. This is exacerbated by high default fees and charges, and an impatience to consume.

When households lose income unexpectedly, they may skip debt payments (such as credit card payments) rather than lower their consumption. Given that most everyone will experience unanticipated income changes at some point, one may expect that a majority of households fell (at least temporarily) into financial distress sometime between 1999 and 2016. The findings in this post challenge that view: The data show financial distress to be highly concentrated in a relatively small share of the population.

Measuring Financial Distress

We used data from the New York Federal Reserve Consumer Credit Panel/Equifax to show the concentration of debt delinquency across a nationwide sample of people with credit reports. “Total delinquency” refers to the total number of quarters in which people in our sample had debt payments that were 120 days delinquent or more.

The graph below orders the population from least financial distress to most and presents the portion of total delinquency accounted for by every population centile. This is done in two separate lines for credit card debt and for any kind of debt.1

debt delinquency

Debt Delinquency Concentration

The first major fact to emerge is that debt delinquency was highly concentrated over the period 1996-2016. About 60 percent of people never have debt payments 120 days late. On the other extreme, 20 percent of people accounted for 80 percent of financial distress, and around 10 percent of people accounted for 50 percent.

This points to the fact that delinquency is frequent among those who experience it. In fact, more than 30 percent of people who had debt 120 days delinquent at any point in our sample spent at least a quarter of their time in that state.

Effect of Credit Card Delinquency

A second major fact to emerge is that much of the trend in financial distress concentration was driven by credit card delinquency. This makes sense given that credit cards are a widely used debt instrument.

Addressing Financial Distress

In light of the remarkable concentration and persistence of financial distress, it is important for policymakers to be able to disentangle the causes. What factors drive some people to be in financial distress for so long and others to never experience it?

In a working paper titled “The Persistence of Financial Distress,” Fed economists Juan M. Sánchez, José Mustre-del-Río and Kartik Athreya examined this question.2 Specifically, they showed that while traditional economic models of defaultable debt cannot account for the observed concentration and persistence of financial distress, a model which also accounts for high penalty rates on delinquent debt and individuals’ heterogeneity in impatience to consume can do so with a high degree of accuracy.

NAB launching Alipay in Australia

National Australia Bank is rolling out Chinese QR code payment method Alipay across the country, with the bank to offer it to its Australian business customers from 2019.

NAB featured an article on this earlier in the year:

Is Alipay open to Australian shoppers?

You need to have a Chinese passport to set up an account with Alipay for making purchases, so using Alipay as a payment method won’t be possible for most Australians. Our strategy is to grow acceptance of Alipay among Australian merchants so Chinese consumers have a payment method that’s familiar to them, whether they’re migrants, tourists or students. This benefits local businesses, putting them in a better position to attract Chinese consumers. It’s important to remember that Alipay is not a competitor to banks in Australia; we’re a partner.

What kind of take-up is Alipay seeing in Australia and what kinds of businesses are using it?

Alipay is the preferred payment method for Chinese people visiting Australia. We partner with close to 10,000 merchants nationwide and the take-up is growing significantly. The types of Australian businesses using Alipay tend to be retailers, including those located in Chinatowns as well as prominent tourism locations like Sydney’s The Rocks and Melbourne’s Federation Square.

Alipay lets shoppers scan QR codes with their phones to simplify mobile payments. What’s the potential for QR code payments to take off in Australia?

QR codes are increasingly a popular part of the payment process in China. For example, people scan QR codes to do everything from making donations to street musicians to controlling the temperature in hotel rooms. Alibaba’s Hema supermarkets throughout China have, for example, been developed to help bridge the gap between online and offline retail: all goods in Hema supermarkets feature QR codes. The codes aren’t just about payments, either; customers can scan the QR codes to learn more about the product. Alibaba is on a big growth drive there – this year, the number of Hema stores in Beijing will grow from five to 35.

How can Alibaba help Australian businesses looking to make headway in China?

Australia is already the third highest selling country into China on Alibaba’s Tmall Global online retail platform, with Australian brands such as Swisse and Bio Island among the most successful merchants on the platform globally. With more than 1,300 Australian brands selling on Tmall Global, many of which entered China for the first time through our platform, Alibaba remains central to their China strategy.

However, Alibaba doesn’t just offer an ecommerce platform. Our vision is to build the entire operating infrastructure to allow businesses to expand globally. In Australia, we launched our cloud computing arm Alibaba Cloud in 2016, while a growing number of merchants are offering Alipay. Longer-term, we’re planning to bring the full benefits of the Alibaba ecosystem to our partners and merchants across Australia.

 

And this on their announcement:

Enterprises with a NAB merchant terminal will be able to offer Chinese travellers Alipay in-store, along with access to promoting their businesses on Alipay’s marketing platform, which now holds 870 million active users.

Shane Conway, executive general manager of deposit and transaction services at NAB said that more than 1 million Chinese tourists visit Australia each year, spending more than $11 billion.

“By making China’s number one payment method available to NAB business customers, we’re enabling greater customer service and providing our business customers with access to this large tourism sector which is a win-win for everyone,” Mr Conway said.

“We’re beginning pilot testing with a small group of business merchant customers in November, before making the payment system available to all merchants through existing point-of-sale terminals in early 2019.”

George Lawson, country manager of Australia and New Zealand at Alipay said he is delighted to partner with NAB to help their business customers across the country connect to the expanding number of Chinese tourists.

“China is now Australia’s largest tourism market accounting for 81 per cent of the growth in tourism spend in Australia in the last 12 months. Enabling seamless payments with Alipay represents a significant commercial opportunity for Australian businesses,” said Mr Lawson.

He said the deal provides tens of thousands of merchants the ability to switch-on Alipay seamlessly and reduce friction at the point of sale for Chinese visitors, residents and students.

“Beyond facilitating transactions, Alipay’s marketing platform drives incremental customers and revenue as it offers the best exchange rates and reduces the anxieties associated with using a foreign currency,” Mr Lawson said.

“We expect this deal will give NAB a significant advantage among business owners wanting to capitalise on the China opportunity.”

Reforms On Incentives To Centrally Clear Over-the-counter Derivatives

The Financial Stability Board (FSB), the Basel Committee on Banking Supervision (BCBS), the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) has published their final report on Incentives to centrally clear over-the-counter (OTC) derivatives.

The total value of OTC derivatives was recently reported at US$595 Trillion, a massive number. The approach is been to allow the growth of these instruments, but to encourage central clearing rather than bi-lateral dealer arrangements to give greater visibility to the exposures involved.  They propose capital incentives for centrally cleared transactions.

We discussed this in a recent video. This is a highly speculative market, and whilst shining more light on them may help, the more fundamental question which should be asked is why allow these to exist at all. The financial markets would be safer if they were limited to only underlying transactions, not speculative positions.   At the moment, there is a risk that the derivatives markets could swamp, and bring down the normal banking system in a crisis, and that risk remains un-quantifiable.  Another reason for structural separation.

 

The central clearing of standardised OTC derivatives is a pillar of the G20 Leaders’ commitment to reform OTC derivatives markets in response to the global financial crisis. A number of post-crisis reforms are, directly or indirectly, relevant to incentives to centrally clear. The report by the Derivatives Assessment Team (DAT) evaluates how these reforms interact and how they could affect incentives.

The findings of this evaluation report will inform relevant standard-setting bodies and, if warranted, could provide a basis for fine-tuning post-crisis reforms, bearing in mind the original objectives of the reforms. This does not imply a scaling back of those reforms or an undermining of members’ commitment to implement them.

The report, one of the first two evaluations under the FSB framework for the post-implementation evaluation of the effects of G20 financial regulatory reforms, confirms the findings of the consultative document that:

  • The changes observed in OTC derivatives markets are consistent with the G20 Leaders’ objective of promoting central clearing as part of mitigating systemic risk and making derivatives markets safer.
  • The relevant post-crisis reforms, in particular the capital, margin and clearing reforms, taken together, appear to create an overall incentive, at least for dealers and larger and more active clients, to centrally clear OTC derivatives.
  • Non-regulatory factors, such as market liquidity, counterparty credit risk management and netting efficiencies, are also important and can interact with regulatory factors to affect incentives to centrally clear.
  • Some categories of clients have less strong incentives to use central clearing, and may have a lower degree of access to central clearing.
  • The provision of client clearing services is concentrated in a relatively small number of bank-affiliated clearing firms and this concentration may have implications for financial stability.
  • Some aspects of regulatory reform may not incentivise provision of client clearing services.

The analysis suggests that, overall, the reforms are achieving their goals of promoting central clearing, especially for the most systemic market participants. This is consistent with the goal of reducing complexity and improving transparency and standardisation in the OTC derivatives markets. Beyond the systemic core of the derivatives network of central counterparties (CCPs), dealers/clearing service providers and larger, more active clients, the incentives are less strong.

The DAT’s work suggests that the treatment of initial margin in the leverage ratio can be a disincentive for banks to offer or expand client clearing services. Bearing in mind the original objectives of the reform, additional analysis would be useful to further assess these effects.

In this regard, the Basel Committee on Banking Supervision issued on 18 October a public consultation setting out options for adjusting, or not, the leverage ratio treatment of client cleared derivatives.

The report also discusses the effects of  clearing mandates and margin requirements for non-centrally cleared derivatives (particularly initial margin) in supporting incentives to centrally clear; and the treatment of client cleared trades in the framework for global systemically important banks.

The final responsibility for deciding whether and how to amend a particular standard or policy remains with the body that is responsible for issuing that standard or policy.

The BCBS, CPMI, FSB and IOSCO today also published an overview of responses to the consultation on this evaluation, which summarises the issues raised in the public consultation launched in August and sets out the main changes that have been made in the report to address them. The individual responses to the public consultation are available on the FSB website.

The five areas of post-crisis reforms to OTC derivatives markets agreed by the G20 are: trade reporting of OTC derivatives; central clearing of standardised OTC derivatives; exchange or electronic platform trading, where appropriate, of standardised OTC derivatives; higher capital requirements for non-centrally cleared derivatives; and initial and variation margin requirements for non-centrally cleared derivatives.

CBA Stands Firm on Bonuses

On Monday (19 November), the seventh and final round of the royal commission hearings kicked off with CBA chief executive Matt Comyn being grilled over the group’s remuneration structures, via InvestorDaily.

Counsel assisting Rowena Orr questioned the major bank boss about frontline staff receiving ‘short-term variable remuneration’, or STVR.

“Short-term variable remuneration is what many people would think of as an annual bonus, is that right?” Ms Orr asked.

“Yes,” Mr Comyn confirmed. “We do not refer to it in that way, but it is a bonus.”

While he admitted that the bank has made a number of changes to its remuneration structure, including work towards the Sedgewick recommendations, Mr Comyn explained why CBA is standing firm on bonuses.

“We believe it is important to have an element of remuneration which is not fixed. We believe it is a well-designed set of metrics or a way for them to earn their short-term variable remuneration; it is both a way of eliciting discretionary effort and a way beyond termination as a form of consequences. It is also a way to make consequences clear to individuals,” he said.

After being prodded by Ms Orr for clarification, the CBA chief explained that “discretionary effort” is the difference between what staff might have otherwise have done if they were paid a fixed salary.

Ms Orr asked why staff can’t be motivated simply by being paid a fixed salary.

Mr Comyn used an offshore example to try and illustrate his response, alluding to a female employee at one financial institution in the United Kingdom that decided to stop paying bonuses.

“I’m talking specifically about a home lender. What they were in effect paid was 98.5 per cent of their prior year’s fixed remuneration and short-term variable reward. So they were guaranteed that remuneration,” he said.

“When I asked her what had changed, her answer was simply ‘I probably work 30 per cent less’. She was one of their best performing lenders.”

Mr Orr offered alternative ways of motivating staff instead of a bonus: “positive feedback for their performance; encouraging them to take pride in their work; encouraging them to have a sense of satisfaction in helping one of your customers; giving them additional responsibilities as a reward for performance; promotion; a higher base salary.”

Mr Comyn said all of these were appropriate ways of driving staff. However, he maintained that CBA has decided for now to continue using short-term variable rewards, or bonuses, to motivate fits sales force

Why Easy Credit Is Not So Easy Anymore

From MPA.

More talk of credit tightening.

I think most of you will agree that in the past getting approved for a credit card wasn’t exactly difficult. I’ve heard some jokingly say that if you had a pulse you could get a card. A little cynical perhaps, but the fact is banks loved approving credit cards. It’s no mystery why, as where else could they generate those sorts of returns?

I’m sure you recall going to a shopping centre or airport and being accosted by an overly enthusiastic bright-eyed credit card salesperson. They couldn’t wait to get you a nice, new shiny credit card, perfect for buying things you didn’t need, with money you didn’t have. Between letters and emails sent by the banks with headings like, “You have been approved!” before an application had even been lodged, to credit cards being offered by anyone from supermarkets to airlines, the banks’ addiction to credit cards was obvious.

For better or for worse this may all be about to change. New regulations with regard to credit cards came into effect on July 1st with more to follow early next year.

One of the big issues being looked at is the time it takes for many people to pay off their credit cards. I can’t think of another type of loan where, with minimum payments, the loan may take longer than the borrower’s lifespan to retire. I’ve seen many credit card statements where the micro writing at the bottom of the page says something like, “At the minimum payment this debt will take 72 years to pay off”. I know life expectancy is improving, but come on! Can you think of another type of loan where the payments would outlive the borrower?

The government is onto this and is concerned about people that cannot pay down their credit cards within a reasonable period and are being exposed to high interest charges as a result. While the banks are publicly agreeing with this, the cynical side of me feels they would be quite happy to leave things as they are.

Following on from this, ASIC recently produced a report which put forward that credit card applications should be assessed on the basis that the credit limit can be retired within three years. It’s looking like this will become policy starting January 2019.

This will be a game changer and will instigate a massive change to how credit card applications are assessed. It’s a welcome change as it will help save people from themselves and hopefully ease household debt levels that seem to be ever increasing, with much of it on credit cards. One thing is for sure, it will mean getting approved for a credit card will be much tougher and this may even result in the review and possible adjustment of current credit card limits.

The days of the banks pushing limit increases are also over. It wasn’t long ago that people would receive endless letters and emails offering to increase their limits. It always struck me as odd that when someone was applying for a home loan they had to provide endless amounts of supporting information, but if they wanted a credit card it was often just a few mouse clicks away.

It appears the banks’ desire to benefit from high interest generating products clouded their judgment when applying sensible lending policies. In other words, the higher the return the lower the scrutiny.

New regulations now prohibit banks from pushing unsolicited credit limit increases which is a very good thing, as offering more and more credit to often venerable people was in my opinion predatory behaviour and not at all responsible.

The royal commission continues to reveal questionable behaviour by the banks and I feel further reform is on the way, but I do have a concern.

While we all want the banks to behave, we’re already seeing lending tightening up and this is causing real issues for people and businesses— and potentially the economy. Many people are quick to cry foul of the banks however let’s not forget that we are a credit-driven society and if credit dries up, everything else tends to dry up too and we all suffer.

I would like to think some middle ground will be found, where banks will act more responsibly when approving credit, but will remain open for business with providing credit in general.

Author: John Dickinson director of DebtX Mediation Services.

Credit Squeeze Puts Brake on Home Building

“An unexpected tight squeeze on credit for home buyers is accelerating the slowdown in building activity,” said Mr Tim Reardon, HIA Principal Economist.

HIA released its quarterly economic and industry outlook report today. The State and National Outlook Reports include updated forecasts for new home building and renovations activity for Australia and each of the eight states and territories.

“The credit squeeze that has been impeding investors for the past 18 months has expanded and is now restricting building activity across the market,” added Mr Reardon.

“APRA’s restrictions were designed to curb high risk lending practices but we are now seeing ordinary home buyers experience delays and constraints in accessing finance.

“This disruption in the lending environment is impacting on the amount of residential building work entering the pipeline. The effect on actual building activity will become more evident in the first half of 2019.

“The credit squeeze is weighing on a market that had already started to cool from a significant and sustained boom.

“If these disruptions to the home lending environment prove to be long lasting then we could see building activity retreat from the recent highs more rapidly than we currently expect.

“The decline in housing finance data shows that something in the lending environment has changed. Lending to owner-occupiers building or purchasing new homes fell by 3.6 per cent in September and is down by 16.5 per cent over the year.

“The year 2017/18 saw over 120,000 detached house starts. This is one of the strongest results on record. We expect new home starts to decline by 11.4 per cent this year and then by a further 7.4 per cent next year in 2019.

“With the prospect for the release of the Hayne Royal Commission’s findings to trigger further upheaval in the banking system, we need the banks maintain stable lending practices for fear of a destabilising influence on the housing market,” concluded Mr Reardon.