Australia still the rich world’s odd man out on rates

SYDNEY (Reuters):  Australia’s central bank is pondering whether to take its foot off the policy brakes at a time when most of their rich-world peers are desperately trying to find an accelerator for their sputtering economies.

 Seeking to head off inflationary pressures, the Reserve Bank of Australia (RBA) has kept rates at 4.75 percent for almost a year, a level it terms “tighter than normal”.

 But a darker economic outlook abroad and downward revisions to core inflation at home have led the RBA to flag the prospect of a cut in rates. In this case, it is not so much a question of whether the economy requires stimulus but whether it still needs to be restrained.

 “They must be wondering whether policy needs to be on the tight side of neutral given everything that’s happening globally,” said Brian Redican, a senior economist at Macquarie.

 A slower world is a potential pot hole for a small open economy like Australia that relies heavily on exports of commodities such as coal and iron ore.

 The threat has already been enough to trigger an outbreak of easings in emerging nations.  

 Indonesia surprised everyone this week by cutting rates, following moves by Brazil and Israel. The latter drew attention because Israel was the first central bank to tighten after the global financial crisis, narrowly ahead of the RBA.

 Bank of Israel Governor Stanley Fischer cited the threat of slower global growth for his surprise cut. That concern was echoed by the RBA last week when it noted forecasts for global growth had been cut back to no better than average.

 “There’s also an argument that the ‘neutral’ rate is lower now than in the past given debt is so high, nobody’s borrowing and credit growth is the slowest in 35 years,” said Redican.

 A neutral level for rates is one that neither stimulates nor retards economic growth and until this year the RBA had estimated it to be around 4.5 percent for Australia.

 The current rate of 4.75 percent would not, then, seem very restrictive but its impact on borrowing argues otherwise.

 Annual growth in the total stock of credit has slowed to just 3.0 percent, far from the 16-percent peak seen in 2007.

 Likewise, annual growth in the A$1.2 trillion of outstanding mortgage credit is down at 5.8 percent. That was the slowest since records began in 1976 and a long way from the 18 to 21 percent pace typical of the first half of the last decade.

 Mortgage rates have also been high enough to take all the heat out of the housing market, with home prices slipping by just over 3 percent in the year to August, according to property consultants RP Data Rismark.

 Household debt is 154 percent of disposable income and interest payments take up 11.7 percent of income, not far from the peak of 13.6 percent in 2008 when rates were much higher.

 Australian mortgages also have a unique characteristic in that fully 95 percent of them are on variable rates, easily the highest share of any developed nation.

 This makes monetary policy a very powerful tool.

 For an average mortgage of A$300,000, a hike of 25 basis points equals an extra cost of A$600 a year. Since over a third of Australia’s 8.5 million households have a mortgage, even a modest tightening in policy represents a large drag on incomes.

 Equally, that means even a modest cut in rates would give a sizable boost to incomes and provide a direct and rapid stimulus to the economy.  Such power can only be dreamt of by central banks in the

United States, Japan and UK where rates are near zero and policy makers are trying ever more exotic, and controversial, means to stimulate their economies. The need for a restrictive stance on Australian rates has also been questioned by a fortuitous turn in domestic inflation after the government’s statistician revised down two key measures of core prices.

 These had initially shown an alarming rise of 0.9 percent in the second quarter, from the previous quarter, and were a major reason the RBA actually considered hiking rates in August.

 The bank must now be relieved it held fire because the launch of a new seasonal adjustment process has seen the rise in underlying inflation revised down to an average 0.6 percent.

 “Recently revised data show a pick-up to date in the underlying pace of price rises that was less sharp than initially indicated,” the RBA said after its October meeting.

 A reduction of three-tenths of a percentage point might not sound like much but when the RBA is trying to keep inflation in a band of 2 to 3 percent over time, it is a big deal.

 The bank had forecast underlying inflation would reach 3.25 percent by year-end, breaching the top of the target band. The revisions may allow that to be trimmed back to 3 percent when the forecasts are updated on Nov. 4.

 Much, however, will depend on what inflation figures for the third quarter show when released on Oct. 26.