RBA – Page 71 – Digital Finance Analytics (DFA) Blog

So Just How Much Are Home Prices Rising?

The statistical “fog of war” appears to have descended on Australian home prices, partly fueled by the RBA’s recent statements, and the latest chart pack data. Because of perceived issues with the CoreLogic data series, we see plots from a number of data providers, including the ABS (whose June 2016 data should be out later on – they are disgracefully slow on releasing their quarterly price data).

Now, we see there are some significant variations between the series, and of course in turn mask the significant differences between locations. CoreLogic has been tweaking their series, and the RBA specifically mentioned this in their recent report. These differences are driven by different methodologies, as well as some series breaks.

So, what is the truth about home price momentum? Of course the RBA wants to show prices growing more slowly despite the cut in the cash rate, thanks to their careful management; whilst others want to talk up the positive movements, to encourage more transactions. Our surveys suggest demand is still quite strong.

As best we can tell, price momentum did moderate in recent months, but now is on the rise again, thanks to low rates, and ongoing interest from investors. Somewhere between 2.5% and 7.5%! The high auction clearance rates appear to confirm this.

But, the real amount of the movement is uncertain. Yet another example of the problems we have getting meaningful, prompt and reliable statistics in Australia.

No Change to RBA Cash Rate Today

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

The global economy is continuing to grow, at a lower than average pace. Several advanced economies have recorded improved conditions over the past year, but conditions have become more difficult for a number of emerging market economies. Actions by Chinese policymakers have been supporting growth, but the underlying pace of China’s growth appears to be moderating.

Commodity prices are above recent lows, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.

Financial markets have continued to function effectively. Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative.

In Australia, recent data suggest that overall growth is continuing, despite a very large decline in business investment, helped by growth in other areas of domestic demand and exports. Labour market indicators continue to be somewhat mixed, but suggest continued expansion in employment in the near term.

Inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.

Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.

Supervisory measures have strengthened lending standards in the housing market. Separately, a number of lenders are also taking a more cautious attitude to lending in certain segments. The best available information suggests that dwelling prices overall have risen moderately over the past year and growth in lending for housing purposes has slowed. Considerable supply of apartments is scheduled to come on stream over the next couple of years, particularly in the eastern capital cities.

Taking account of the available information, and having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

AU$ Forex and Derivative Volumes Down

In April 2016, the Reserve Bank conducted a survey of activity in foreign exchange and over-the-counter (OTC) interest rate derivatives markets in Australia. Using data from the BIS and the RBA summary, here is a snapshot. This was part of a global survey of 52 countries, coordinated by the Bank for International Settlements (BIS). Similar surveys have been conducted every three years since 1986.

Globally, the Australian dollar remains the fifth most traded currency, although its share of turnover decreased by 1½ percentage points to around 7 per cent.

The AUD/USD remains the fourth most traded currency pair, having also accounted for a slightly decreased share of global turnover.

Activity in Australia’s foreign exchange market has moderated since the previous survey in April 2013. Total turnover fell by around 25 per cent, compared with a 5 per cent decrease in global turnover over the same period.

Nonetheless, the Australian foreign exchange market remains the eighth largest in the world.

Activity in Australian OTC interest rate derivatives markets declined markedly over the three-year period, primarily reflecting a decline in turnover of forward rate agreements.

The BIS data highlights the high volume of US$ Swaps, relative to other currencies. AUD is in fourth position.

The USA and UK dominate the derivative markets, with Australia in seventh position.

The preliminary results of the global turnover survey and links to other participating jurisdictions’ results are available from the BIS website. More detailed results for the Australian market are available on the 2016 BIS Triennial Survey Results – Australia page.

The BIS will also publish global data on outstanding OTC derivatives as at June 2016 in November.

The Reserve Bank will publish Australian data on outstanding OTC derivatives at that time.

RBA Expects Inflation To Rise, Later

The RBA released their minutes today of the meeting where rates were cut to a record low 1.5% in August 2016.

They highlighted the property market and commented on both the slower rate of house price growth, and dwelling investment momentum.

Dwelling investment was expected to increase further, having grown strongly in recent years, although the contribution to output growth was expected to diminish over the forecast period. Building approvals had declined over the preceding year, but remained at high levels and had exceeded the amount of work completed. As a result, the number of dwellings under construction had increased to very high levels. Further, members noted that the pipeline of residential construction work, which included work that had not yet commenced, had increased the risk of oversupply in parts of the country. The outlook for the balance of supply and demand in the housing market was important for the inflation outlook because housing costs make up a significant share of the CPI basket.

Turning to the established housing market, members noted that most indicators pointed to an easing in conditions since late 2015. Recent data indicated that housing prices appeared to have grown modestly in the June quarter and had declined a little in most capital cities in July. Data on housing price growth from CoreLogic, which had been discussed at previous meetings, indicated that housing prices had increased very strongly in several cities in April and May. However, new information had revealed that these growth rates were overstated because of changes to CoreLogic’s methodology; data from other sources indicated that housing price growth had instead remained moderate in the June quarter. Other information showed that, while auction clearance rates had recently picked up a little in Sydney and Melbourne, the number of auctions was lower than in the preceding year and the average number of days that properties were on the market had increased. Housing credit growth had been little changed in recent months and remained below that of a year earlier. Rent inflation had declined to its lowest level since the mid 1990s and the rental vacancy rate had drifted higher to be close to its long-run average.

In addition, they think inflation will rebound, later. However there is significant uncertainty.

Members noted that there was little change in the forecast for underlying inflation. The central forecast was still for inflation to remain around 1½ per cent over 2016 before increasing to between 1½ and 2½ per cent by the end of the forecast period. The substantial depreciation of the exchange rate over recent years was expected to exert some upward pressure on inflation for a time and inflation expectations were assumed to return to longer-run average levels. The forecast increase in underlying inflation also reflected the expectation that strengthening labour market conditions would lead to a gradual rise in growth in labour costs. In particular, members noted that growth in average earnings had been low given the spare capacity in the labour market. Moreover, growth in average earnings had been affected by lower wage outcomes in sectors related to the mining industry as a part of the process of adjusting to the lower terms of trade and the end of the mining investment boom. Both of these effects were expected to wane over the forecast period. Members noted that there continued to be considerable uncertainty about momentum in the domestic labour market and the extent to which domestic inflationary pressures would rise over the next few years.

The exchange rate of course has remained pretty strong and is higher than this time last year. So, expect lower inflation for longer.

The legacy of Glenn Stevens in three lessons

From The Conversation.

On September 18 2016, Glenn Stevens will end his ten-year mandate as governor of the Reserve Bank of Australia (RBA). His experience in the top job provides a wealth of lessons for the next generation of policymakers; that’s arguably his most important legacy.

A graduate from the University of Sydney and the University of Western Ontario in Canada, Stevens worked in the RBA research department between 1980 and 1992. He then held positions as department head, assistant governor (economic) and deputy governor. In 2006, he was appointed governor.

Throughout his tenure as governor, Stevens has had to deal with a highly volatile and generally fragile global economic and financial landscape. Domestically, he has been confronted with the end of the mining boom and a prolonged contraction of gross domestic product (GDP) below its potential level.

It is probably not an exaggeration to say that the ten years from 2006 to 2016 have been some of the most difficult economic times in post-war history. But it is exactly this highly complicated environment that provides a valuable learning opportunity for policymakers and for the economics profession more generally.

The monetary policy framework

The first lesson concerns the need for a “risk management” approach to monetary policy in a time of crisis.

The RBA’s monetary policy framework centres on an inflation target of 2%-3% on average over the medium term.

This means that actual inflation may deviate from the target in the short term in response to the cyclical conditions of the economy. For instance, when a negative demand shock reduces GDP below potential and causes unemployment to increase, reduced inflationary pressures allow the RBA to stimulate the economy by reducing the cash rate moderately.

In September 2008, when the global financial crisis hit the world, Australian inflation had been above target and on the rise for three consecutive quarters. This should have made the RBA prudent in cutting interest rates.

Instead, conditions worldwide were such that a change in monetary policy thinking was needed. The risks were simply too large to be treated with a normal policy approach.

Accordingly, the RBA moved to a “risk management” approach that, while broadly consistent with the flexible inflation-targeting framework, allowed for a quick (and much-needed) response.

As a result, the cash rate was reduced from 7.25% to 4.25% in the period September to December 2008 and then to 3% in the course of the first half of 2009. Comparatively, only the Bank of England cut its interest rate by as much as Australia.

The cut in the cash rate largely passed through to commercial lending rates, resulting in an increase in disposable income for many individuals. This then contributed (together with other factors, including the fiscal stimulus) to maintaining the Australian economy out of a recession.

It is highly likely that without this risk-management approach to monetary policy, Australia would have been much more severely affected by the global financial crisis.

The limits of monetary policy

The second lesson is that policymakers ought to be realistic and pragmatic about what monetary policy can and cannot deliver.

Through changes to the cash rate, monetary policy can affect the pace of real economic activity in the short term. But, in the long term, growth and unemployment are driven primarily by supply-side factors and monetary policy only affects inflation.

Moreover, the extent to which monetary policy can affect growth in the short term decreases as interest rates get lower. During the GFC, monetary policy effectively contributed to shielding the Australian economy because higher interest rates gave the RBA more room to cut.

But when interest rates are already low, the monetary policy space is reduced and further cuts are unlikely to produce significant effects.

Understanding the limits of monetary policy is particularly important in the current economic context.

The Australian economy has been operating below potential for several years now, as data from the International Monetary Fund suggests.

In response to this prolonged contraction, the RBA has reduced the interest rate to record low levels. It has reached the point where further cuts would probably be more damaging than beneficial.

Now more than ever recovery becomes a matter of fiscal policy interventions.

How to use monetary policy

The third lesson is about the use of monetary policy.

The inflation-targeting framework requires the RBA to set the cash rate having consideration for a variety of factors and data, including qualitative information received from conversations with businesses, investors and stakeholders.

In making the best possible use of these data and information, the RBA follows two guiding principles.

First, policy should not be driven by conclusions drawn from short runs of data. This then implies that the cash rate should not be fine-tuned continuously in response to marginal developments occurring month by month.

In normal circumstances, the interest rate ought to move gradually and rather infrequently to provide individuals (businesses and households) with some certainty about the course of monetary policy.

Second, monetary policy in Australia ought to be both outward- and forward-looking. An outward look is required because, as a small and open economy, Australia’s inflationary dynamics are heavily affected by developments on international markets.

This does not mean that the RBA should passively mimic the behaviour of other central banks. However, it does mean that the importance of international factors for the Australian economy should be adequately taken into account.

Forward-looking refers to the fact that forecasts ought to play a central role in the monetary policymaking process. To express this in Stevens’ own words:

After all, if monetary policy takes some time – several years – to have its full effect on the economy and inflation, forecasts have to be at the centre of things, don’t they?

Author: Fabrizio Carmignani, Professor, Griffith Business School, Griffith University

How inflation is tied to the property market

Weak inflation has sent interest rates to historic lows, but new housing supply and APRA’s steps to rein in property investment will contain property prices according to an article in The Real Estate Conversation.

While many property owners around the country continue to enjoy strong capital growth, the national inflation rate dropped to 1% in the 12 months to June, according to the Australian Bureau of Statistics (ABS). For what it’s worth, this is below the Reserve Bank’s 2-3% target band and represents the weakest annual rate of inflation in 17 years.Such low inflation would typically mean the economy is weak and unemployment is high. But not in Australia, apparently. A number of commentators say that Australia’s unemployment rate (5.8% as per ABS) is at a stable level and that the economy is ticking along well, even though both company profits and wages are generally down. It’s a confusing mix of circumstances, for sure.

Adding to the complexity, low inflation has seemingly had little effect on the property market, which remains buoyant even after several years of high price growth in cities like Sydney and Melbourne. Prices aside, total housing credit has mostly been up this year (at least for owner-occupiers), and this usually means there are plenty of property buyers out and about and wanting to borrow money.

These buyers are often competing on a limited supply of homes, which is important because the supply-demand equation is central to our reading of the economy. One reason demand for property has so dramatically increased is because of the relatively cheap cost of home loans in recent years, which is due to record low interest rates – 1.5% as of August – implemented by the Reserve Bank (RBA).

The impact of rate cuts

Many media articles lead with the idea that RBA rate cuts are directly linked to the property market. Yet if you read past the headlines, it becomes clearer that the RBA is more concerned with low inflation.

“The RBA is trying to keep inflation at a certain level and the expected outcome from cutting interest rates is a lower dollar,” says BIS Shrapnel senior manager, Angie Zigomanis. “By lowering interest rates it means people will come here [to Australia] and the returns on their investments are lower, and the dollar starts falling on that basis because you’re competing for money.

“It means that the lower dollar starts stoking a lot of the import industries as well. It makes their products more competitive against exports.

“So rate cuts are part of a broader view to ward of inflationary pressures but also to lower the dollar to kick start some other industries that provide economic growth. The housing market is a bi-product [of this].”

Perception is reality

Much of this, of course, is about perception. In other words, high inflation means demand is seen to be strong, and this prompts businesses to invest more, consumers to spend and therefore price to go up.

There are several measures that help the government determine demand levels, like the consumer price index, which gives us that inflation rate figure. It simply measures the changing price consumers pay for goods and services. So in a high inflation environment, prices for the same goods and services are, well, much higher because the underlying demand is so strong.

Right now, CommSec says that price pressures are currently contained in Australia, largely due to greater competition in the market, including online sellers. This means consumers are the main beneficiaries of cheaper prices across all good and services – perhaps with the exception of property prices.

Find the balance

Over the past 20 years general price inflation has been low and stable, consistent with the inflation target since the early 1990s, according to an RBA paper published in 2015. However, such has been the level of property price growth that more recent prices have outstripped the rate of inflation in other parts of the economy, including inflation in the cost of new dwellings.

This has been a concern for the RBA because if property prices go up too high then most money will end up in housing and building instead of sustainable investment in industries, says Zigomanis.

This is why the Australian Prudential Regulation Authority (APRA) last year sought to limit the impact of property investors on the market by capping annual investor credit growth at 10%, which CoreLogic RP Data says has worked well to this point.

NAB Expects More Rate Cuts, And Possibly QE

The latest economic summary from NAB, released today, suggests that the immediate impact of Bexit is more benign than was expected. But NAB says the RBA may need to cut the cash rate to 1%, and even try unconventional policies to try and lift growth in the local economy.

Whilst Australian economic growth is expected to remain resilient at 2.9% in 2016 and 2017, despite significant variation across industries and states, the risks to the outlook going into 2018 are becoming increasingly apparent, as LNG exports flatten off at a high level and the dwelling construction cycle turns down.

Against these headwinds, the economy may require additional policy action to support growth, especially if the RBA hopes to see inflation return to within its 2-3% target band. Both global and domestic disinflationary pressures are expected to keep CPI inflation below the target band for an extended period, while structural shifts in the economy and modest economic growth risk upward pressure on the unemployment rate.

The economy is then expected to lose some momentum in 2018, which together with the very low inflation outlook, will prompt the RBA to cut the cash rate in both May and August 2017 by 25bps each to a historic low of 1%. Even with this extra stimulus, growth is expected to slow to 2.6% in 2018, and the unemployment rate remain reasonably elevated at 5.6%. Price and wage pressures will remain subdued.

Our forecasts are also dependent on further depreciation in the AUD, although there are significant risks around our view that the AUD will track down to a low of USD69 cents by mid-2017, not least due to the reliance on either a Fed or a volatility-induced rise in the USD, which cannot be guaranteed. A lower iron ore price (as per our forecasts) would also assist the currency.

The composition of the new Australian parliament suggests that achieving consensus on microeconomic and tax reform will be challenging, while the threat of a rating downgrade by S&P will see continued emphasis on fiscal consolidation. This will continue to place pressure on monetary policy and any further deterioration in the growth outlook following the cuts in May and August 2017 is likely to prompt consideration of non-conventional monetary policy tools such as asset purchases.

We now expect the RBA will need to provide further support through two more 25bp cuts in May and August 2017 (to a new low of 1%), which should be enough to stabilise the unemployment rate at just over 5½% and prevent economic growth from dropping below our forecast of 2.6% in 2018.

Monetary policy deliberations may then turn to the possible use of non-conventional policy measures if the outlook deteriorates further.

Additionally, persistent weakness in CPI inflation could potentially trigger a rate cut even sooner than expected.

RBA Suggests House Price Growth Was Overstated

The latest statement on monetary policy, released by the RBA today, discusses the normal range of issues. However, one point of note is the apparent overstatement of the CoreLogic home price data in April and May.

A range of indicators suggest that conditions in the established housing market have eased this year from very strong conditions over recent years. Housing prices were little changed in the June quarter according to most published measures. In contrast, the headline CoreLogic measure of housing prices recorded very strong growth in April and May in a number of cities, to be more than 5 per cent higher over the June quarter.

Recent information suggests that the strong increases reported by CoreLogic were overstated as a result of methodological changes affecting growth rates for the June quarter.

Here is what CoreLogic told their customers.

As part of continual efforts to improve our analytics, filters which are applied to the CoreLogic hedonic index methodology were updated progressively through April.  Static price filters were previously applied to the hedonic index method which were designed to trim extreme transaction prices from the index calculation.  In April, after a periodic model review, CoreLogic revised the filtering method to be dynamic. 

The model recalibration should reduce index volatility and provide more accurate measurements of capital gains going forward.  Additionally, the price filter adjustment should alleviate seasonal changes that were historically evident in the index series during May and June. 

As a result of these changes, we recorded higher than normal intra-month volatility in the capital city index readings during April and May.  The combined capitals index rose 1.7% in April and 1.6% in May before reducing to 0.5% growth in June and, most recently, 0.8% in July.

The changes are part of a once off project aimed at improving the hedonic measurement of capital city home values.  The next major iteration of improvement will occur over the second half of 2016 as we migrate our indices to the new ASGS capital city boundaries.  This update will involve a revised back series of the hedonic index according to the new geography and we expect to release this to the market during Q4 2016.

The most recent data suggest that housing prices declined in most capital cities in July.

Other timely indicators of conditions in the established housing market continue to point to weaker conditions than last year. Auction clearance rates and the number of scheduled auctions are lower than a year ago and there has been a large decline in the number of transactions in the housing market, which is reflected in the turnover rate. In the private treaty market, the discount on vendor asking prices has been little changed of late, but the average number of days that a property is on the market has increased from the lows of last year.

Total housing loan approvals have been little changed in recent months. Meanwhile, housing credit growth has been steady in the first six months of the year but slower than in 2015, consistent with a relatively low level of turnover and the tightening of lending standards towards the end of 2015. The upswing in dwelling investment, particularly the construction of high-density dwellings, has continued, supported by low interest rates and earlier increases in housing prices. Residential building approvals are lower than their peak of mid 2015 but remain at high levels.

Indeed, building approvals have continued to exceed completions, resulting in the number of dwellings under construction or yet to be completed reaching historically high levels. The work in the pipeline is sufficient to underpin dwelling investment activity for the next couple of years.

Conditions in the rental market have continued to soften over the past year. The aggregate rental vacancy rate has drifted higher to be close to its longer-run average of around 3 per cent and rental inflation is around multi-decade lows, having eased across most capital cities. The Perth rental market is particularly weak, reflecting the slowing in population growth combined with ongoing additions to the housing supply.

Bank executives forced before parliamentary committee for ‘regular health check’

From The Conversation.

Malcolm Turnbull has announced that the heads of Australia’s big four banks will be grilled annually by the House of Representatives economics committee, as the government hits back at the banks’ refusal this week to pass on the full interest rate cut.

Turnbull, who fronted the media with Treasurer Scott Morrison, said the banks “operate under a social licence”. “They are built on a foundation of trust and they have to earn that trust through being open and accountable at all times.”

In what the government dubs a “regular health check”, Turnbull said the banks would appear at least once a year “to give a full account of the way in which they are managing their affairs, their dealing with customers, their interest rate policy”.

The banks would be regularly accountable to the Australian people through parliament “in exactly the same way as the Reserve Bank and APRA [the Australian Prudential Regulation Authority],” he said. The appearances would be part of the “regular financial calendar”.

The move follows Turnbull’s Wednesday tongue-lashing of the banks for passing on only part of the 25 basis points cut, and the pressure the government has been under from Labor which continues to advocate a royal commission into the banks.

The banks will be required to explain:

international economic and financial market developments and how they were affecting Australia

developments in prudential regulation, including capital requirements, and their effect on Australian banks’ policies

the costs of funds, impacts on margins, and the basis for bank interest rate pricing decisions

how individual banks and the industry as a whole were responding to issues previously raised in parliamentary inquiries through their package of reforms announced in April

bank perspectives on the performance of the Australian economy.

Continuing his attack of earlier this week, Turnbull said there was “no commercial basis… other than to improve their profitability,” for the banks not to pass on the full rate cut. “They must provide a full account of why they have not done so.”

He said the new requirement “will become, if you are a bank chief executive appearing before the House economics committee, part of your regular annual schedule”. He noted that the committee could have additional hearings and call people back.

Morrison said the government had been in touch with the banks about its announcement and had also consulted with the Reserve Bank and the Australian Competition and Consumer Commission and had advised APRA. “So there’s been an appropriate assessment and consideration of how this process would work.”

The Australian Bankers Association chief executive Steven Munchenberg said the government was entitled to call the banks before a parliamentary committee but noted pointedly that “no other businesses are required to justify their commercial pricing decisions in this way”.

“We are confident banks can explain why the interest rates they set for borrowers are determined largely by the costs of funds and the pressures of a highly competitive market, not the Reserve Bank cash rate.”

He said that in making interest rate decisions “banks have to balance the needs of borrowers and savers, and shareholders in banks, most of whom are also ordinary Australians”.

Opposition Leader Bill Shorten said Turnbull was protecting the banks.

This response was a “cop out” from a weak prime minister who was “in the pockets of the big banks”.

“There is nothing Mr Turnbull won’t do to protect the big banks from a Royal Commission. After giving them a $7 billion tax cut, he’s now inviting them to lunch in Canberra once a year so he can wag his finger at them. This is a friendly catch-up, not an investigation,” Shorten said.

Shorten said that Turnbull was only doing what the banks would let him do. “We know this because he admitted he checked with them to see if this is okay.”

Author: Michelle Grattan, Professorial Fellow, University of Canberra