RBA Governor testimony to Parliamentary committee

RBA Governor's testimony to Parliamentary committee

RBA Governor Glenn Stevens today delivered his six-monthly testimony to the House of Representatives Standing Committee on Economics, Finance and Public Administration. The Governor delivered a prepared statement that echoed the hawkish tone of Monday's Statement on Monetary Policy, and took questions from Members of Parliament. The tone of the Governor's comments deviated very little from that of the quarterly statement, which implied that the RBA retains a clear bias to tighten policy again. This was despite there now being a higher risk of the increased volatility in financial markets spilling over into the real economy. The maintenance of this hawkish tone means we continue to look for another policy tightening in December. Moreover, a rise in November, which would be just days before the Federal election, still cannot be ruled out.

The Governor referred again to the factors mentioned in Monday's quarterly statement signalling that the tightening bias remains in place. Domestic spending is rising, demand for credit has firmed, household finances are in good shape, demand for Australian exports is rising, and the economy is operating at close to full employment, so the labour market is very tight. Moreover, the global economy has surprised with its strength, and the terms of trade continues to provide significant stimulus to the Australian economy. The Governor indicated today that, on the basis of these developments, and the assumption that core inflation is likely to remain at the top of the RBA's 2-3% target range for some time, officials believed there was a clear case to raise cash 25bp last week. In answer to a later question from an MP, the Governor indicated that the arguments in favour of last week's adjustment in policy remain in place, even after accounting for the subsequent volatility in financial markets.

On the turmoil in equity, credit, commodity and FX markets, the Governor again indicated that the re-pricing of risk and the fall-out from the sub-prime mortgage market poses a downside risk to growth in the US economy, but that growth in other parts of the world have, if anything, been upgraded. RBA officials will continue to monitor market developments but, at this stage, the Governor's comments indicate that RBA officials believe the spill-over to the real economy will be contained. In particular, the Governor revealed that the poor quality mortgage market in Australia is very small (just 1% of total loans), and that the rate of arrears in this tiny segment of the market is much lower than in the comparable market in the US.

One mitigating factor the RBA mentioned when raising the cash rate last week was the likely disinflationary impact of the high AUD which, at the time, was well above 80 US cents. The AUD since has plunged 9% against the USD, and also against most other currencies, which means there now should be less of a dampening impact on inflation in coming quarters from lower import prices. If anything, therefore, there could be slightly more upside risk to the RBA's forecast in Monday's statement that core inflation will be marooned at the top of the target range for an extended period. This means there is a higher chance of the upper band of the RBA's inflation target being breached in coming quarters.

On the basis of today's testimony, we continue to look for further policy tightening later this year. This forecast is, however, conditional upon two things. First, that stability has returned to financial markets and, second, that the spillover of re-pricing of risky assets to the real economy will be contained. If markets are still in turmoil by the time the next 'live' Board meeting comes around, which is unlikely, the RBA will not tighten policy. That said, the Governor indicated that he found it difficult to even contemplate cutting the cash rate in response to, for example, a rate cut by the Fed.

One related real economy factor that could keep the RBA sidelined, which would be a symptom of the re-pricing of risky assets, would be higher mortgage interest rates, which have risen by much more than last week's 25bp increase in the cash rate, owing to the liquidity problems currently being faced by local financial institutions and non-bank mortgage providers. The expansion of prevailing market interest rates over cash will do some of the heavy lifting for the RBA and could negate the need for further tightening. It is, however, too early to gauge where market interest rates will settle relative to cash, but the Governor stated that officials would take the spread into account during policy deliberations.

On the timing of the federal election, which we believe will be held on 10 November, the Governor indicated that the poll will not play a role in policy deliberations. In fact, in answer to a question from an MP, the Governor indicated that if a rate rise is needed immediately after the November Board meeting, which is scheduled for what is likely to be the week before the election, it will be delivered. The Governor stated that he believed the RBA would be abdicating its responsibility to the Australian population if it did not tighten policy owing to the timing of the election, despite a compelling case that the cash rate was too low.

ENDS

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