MNI: Neutral Rate Below Cash Rate - RBA's Kent

The Reserve Bank of Australia believes the 4.35% cash rate above its nominal neutral rate estimate, which it judges to be in a range below 4.0%, according to Assistant Governor Financial Markets Chris Kent.

Speaking at an industry event, Kent noted the cash rate was currently also higher than most market economists forecasts of the nominal neutral rate surveyed by the RBA. (See chart)

“In May, the median estimate among market economists implied that the cash rate was around 1 percentage point above the nominal neutral rate,” Kent added. “In short, these estimates imply that monetary policy is restrictive and so it is continuing to bring aggregate demand into better balance with aggregate supply, as intended. That said, estimates of the neutral rate are subject to considerable uncertainty, so the extent to which monetary policy is restrictive is unclear.”

The RBA board decided to hold the cash rate steady at its most recent policy meeting, despite higher monthly inflation prints. RBA Governor Michele Bullock noted the economy remained on track to pull inflation back to the 2-3% target band, but that path had “narrowed.” (See MNI RBA WATCH: Hikes Discussed As Bullock Steers Narrow Path)

Kent said neutral rate estimates had increased since the pandemic, driven by increased public debt, downward pressure on savings and increases in investment from the public and private sectors.

RESTRICTIVE CONDITIONS

Kent argued overall financial conditions remained restrictive for households, noting the average rate on outstanding mortgages had risen by 335 basis points over the tightening phase to a little over 6%. "Passthrough has been a bit less than in the past because of the high share of mortgages fixed at low rates during the pandemic," he added. "Increased discounting on mortgages by lenders competing for borrowers has also played a role. Nevertheless, the increase in mortgage rates has been large and rapid (See chart). Also, most of the remaining low fixed-rate loans from the pandemic era will expire this year, which will add around 20bp to the average outstanding mortgage rate."

Private enterprise has also experienced restrictive conditions, he added, noting average rates on large business loans have increased by more than 425bp over the tightening phase, compared with around 310bp for small businesses. "However, small businesses continue to face substantially higher interest rates than their medium and large counterparts," he continued.

“Looking across a range of measures shows that monetary policy tightening has led to restrictive financial conditions. However, the extent of this varies across different sectors and also within sectors. Households have been responding to higher interest rates. While households with mortgages are significantly affected, and quite directly, consumption growth is weak for most people. Smaller businesses, and businesses with higher leverage, are also facing financial pressures, much more so than many larger businesses."