REPEAT:MNI INSIGHT: RBA Guidance Vague As Funding Cost Risk Up

Repeats Story Initially Transmitted at 22:14 GMT May 8/18:14 EST May 8

By Sophia Rodrigues

     LONDON (MNI) - The Reserve Bank of Australia appears confident about growth

and inflation prospects that would eventually lead to a hike in the cash rate,

but remains deliberately vague about the timing of the first increase over

uncertainty about how much a rise in funding costs would result in an increase

in bank lending rates.

     If lending rates in the economy rise independent of an increase in the cash

rate, the RBA is likely to delay a rate hike.

     Analysis published by MNI on March 30 had noted how the RBA in the February

Statement on Monetary Policy (SoMP) had completely missed a discussion on a

potential risk to its policy stance from a possible tightening in financial

conditions.

     Three months later, that risk has grown significantly and is now viewed by

the RBA as a real threat to the timing of the first rate hike.

     There are two main elements to that risk:

     -- the rise in U.S. money market rates, for reasons other than the increase

in the federal funds rate, which have had a noticeable knock-on effect on

Australian money market rates

     -- the possibility that global inflation could be higher than expected,

prompting a faster tightening of monetary policy and financial conditions in

major advanced economies than is currently expected, having a flow-on impact on

financial conditions in Australia.

     --FUNDING COSTS UP, BANKS CAUTIOUS

     The rise in Australian money market rates has already resulted in funding

costs of banks increasing to a level they were at end-2016 and two smaller

lenders have raised their variable mortgage rates in response.

     Currently, the RBA is watching developments closely to see how long these

pressures persist but is also aware that some of the increase is likely to be

enduring.

     Banks haven't yet reacted with mortgage rate rises because they are under a

lot of public scrutiny after the Royal Commission into misconduct in the banking

sector. They will be very cautious about such moves and it is likely any rate

increases will be not be as aggressive as banks have done in similar situations

in the past.

     The RBA will be watching how banks react as the impact on monetary policy

would ultimately depend on the size of any such lending rate increases.

     --GLOBAL INFLATION RISK

     If the second scenario comes to pass, the RBA will have an additional and

bigger issue to deal with.

     "Any increase in yields arising from increased inflation expectations would

occur on top of the effects of the recent moderate tightening in money market

conditions in the United States and some other markets, which has occurred for

several reasons unrelated to expectations about monetary policy," the RBA said

in this May's SoMP.

     The RBA didn't specify the impact of this but noted that the "moderate"

rise to date has increased the cost of funding for a range of financial

institutions in Australia as well as the borrowing costs for some businesses.

     --RBA LANGUAGE VAGUE

     Because these uncertainties, if they come to pass, could have a direct

influence on monetary policy, it is reflected in the RBA's forward guidance.

     The RBA incorporated the forward guidance in the May SoMP to reflect its

optimism on the economy's growth and inflation prospects but stopped short of

giving a clearer signal, as they are aware rate hike may be outside their

control if lending rates start rising independently.

     That is why the guidance read, "For some time the Reserve Bank Board's view

has been that holding the cash rate steady at 1.5% would assist that progress,

with steady monetary policy promoting stability and confidence. If the economy

continues to perform as expected, higher interest rates are, however, likely to

be appropriate at some point."

     "At some point" could mean any time in the future.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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