MNI ANALYSIS: RBA Misses Risk That's Threatening MonPol Signal

By Sophia Rodrigues

     SYDNEY (MNI) - In the February Statement on Monetary Policy, the Reserve

Bank of Australia missed a discussion on a potential risk for its policy stance

-- the possibility that financial conditions could tighten and affect the

outlook for interest rates. Less than two months later, that risk looks very

real and is now diminishing the possibility of a cash rate hike later this year.

     It was a just a few weeks back that signals from the Reserve Bank of

Australia suggested that bets on a cash rate hike in November might be

justified. In a speech in early March, Governor Philip Lowe said that the

economy is moving in the right direction, and more progress in reducing

unemployment and having inflation return to target would lead to an increase in

interest rates.

     --TIGHTER CONDITIONS

     In giving the guidance, Lowe missed a key point that was also missed in the

February policy statement -- the possibility that financial conditions could

tighten and push up interest rates.

     If such tightening results in interest rates on mortgages and for small

businesses increasing by around 25 basis points, it would almost eliminate any

chance of the RBA hiking the cash rate later this year, even if the economy made

enough progress in the direction suggested by Governor Lowe.

     In effect, the RBA's job would be undertaken by lenders in the economy.

This wouldn't worry the RBA too much because they have been signalling the

possibility of rates going up in future. But it would eliminate any prospect of

them raising the cash rate.

     At a Q&A following his speech in early March, Lowe said that borrowers have

"been getting the message for some time, including from the Reserve Bank, that

interest rates are going to go up" and they should be prepared for that.

     According to Lowe, because mortgage holders have a reasonable buffer on

interest rates when they take the mortgage and because they have additional

buffer from the offset account, they would be able to manage an increase in

interest rates.

     -SMALL RATE CUT RISK

     However, there is also a small but not negligible risk that any sharp

tightening in financial conditions that lead to greater increases in mortgage

rates, could bring an RBA cash rate cut back on the table. This would be

especially so if a rise in mortgage rates increases the risk of sharp slowing in

housing market activity, leading to a widespread decline in housing prices.

     In a research note published Friday, Westpac discussed the extent of

tightening in financial conditions in Australia from both a fall in the share

market and from a rise in funding costs.

     Westpac explained there has effectively been a short term funding rate

increase for Australian banks of around 25 basis points. This is because of a

widening in the spread between the overnight indexed swap and the Bank Bill Swap

Rate (BBSW) from around 20-25bps last year to around 50bps now.

     Just around two weeks back, major banks announced cuts in mortgage rates on

some fixed interest products. However, a week back a smaller bank -- Suncorp --

announced an up to 12bps rise in variable mortgage rate, citing reasons

including rising funding costs. If pressures on funding costs intensify, it will

be a matter of time before other banks start hiking variable home loan rates.

     Westpac notes funding costs in longer maturities have also risen for

Australian banks, with 5-year paper higher by around 15bps compared to the risk

free rate. 

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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