Fireside Chat Fireside Chat at the Commonwealth Bank’s Global Markets Conference

Again, probably one avenue is just to come back to the macro models that we have, and as imperfect as they are, try and use them to say, given all the shocks that we think are hitting the economy, where monetary policy’s at, is the economy behaving more or less as we might think? And I don’t think there’s any reason that it’s changed dramatically one way or another.

The important mechanisms are still at work through the exchange rate, which I’ve mentioned. That’s helpful and working as you’d think. There’s the wealth channel that’s clearly working through the housing market and dwelling investment, but also the wealth channel should be affecting household consumption.

There’s the intertemporal channel. That’s quite a powerful channel. That’s where higher rates provide an incentive, not just for those who have net savings, but for everyone, including those with debt, to save more, to pay their mortgage down a bit faster if they can. So all those are working. And then the one that gets way too much attention, and we’ve said this before, is the cash flow channel.

And one thing I’ve heard is people saying, well, lots of households have very significant offset accounts, and that dampens the effect of an interest rate increase on mortgage holders’ ability in terms of their constraining their cash flow. And that’s true, but that’s by design. Australian households pay their mortgages down a bit faster, and it’s a way of providing a bit of self-insurance. So if you need to for a time, you can dip into those offset and redraw savings if you have them, and many do.

But I don’t think there’s any evidence that even the cash flow channel’s changed that much. And of course, we can measure that because we have good measures of net household debt which are a lot lower and more stable than just the raw debt numbers would suggest because these offset accounts have been building up so quickly.

So, we’re just too impatient then in waiting to see.

It’s often the case. Still early days in terms of the transmission of monetary policy.

We might turn our attention now just to some of the questions we are getting through. What’s the best way to measure how tight financial conditions are right now? I know we’ve spent, as a team, a lot of time looking at this. I know it’s a question that comes up in a lot of the meetings that I have, and it’s obviously come up from the audience now. But how do you measure it, or what do you think is the best way to measure it?

I think the best way is to look at a huge range of data. So there is no silver bullet. There is no magic number that we’ve got secretly tucked away that we just don’t reveal to people.

I said we start, and I think it’s a useful starting point, but that’s all it is, with these estimates of neutral. And there’s a wide range of models that we have, and each of the models is estimated itself with some uncertainty. And we often talk about the range of central estimates, and then there’s more uncertainty on top of those. But in terms of that range of central estimates, the cash rate and the cash rate path looking forward for the next 18 months or so, sits at the upper end of that range of estimates. So that tells you, you can have some confidence that monetary policy is somewhat restrictive, but the question is, is it restrictive enough?

And again, those estimates are subject to lots of uncertainty and revisions. So that’s a starting point.

I think the other thing you can and should do is look separately at the effects that you would be expecting to see when you tighten monetary policy. And we have seen that. We’ve seen, probably through our exchange rate models, the interest rate differential started to move higher late last year, where our inflationary pressures were picking up, and the markets were thinking we were going to have to respond to that. And the exchange rate’s been behaving more or less as we might think, and if anything, at the margin, maybe a bit more appreciated than you might think.

And then you can look at the flow of funds through credit growth, for example, and housing credit growth has been weakening, and that’s what you would expect, and it’s got an extra kick down because of the changes affecting investors, the tax changes.

So, we see house prices, housing turnover, dwelling investment, all of those sorts of things in terms of the forward-looking indicators softening. So that’s much as you’d expect. We do see a weakening in household consumption growth. But then on the other side of things, looking at some other stuff we think about, and that’s business credit. Business credit has been growing really strongly. Some of that’s funding for data centres, but not all of it. It’s broader base than that.

So corporate balance sheets are being used to tap into extra funding, and there’s internally generated funds as well. And then we look at things like credit spreads, equity risk premia. And in the main, they have suggested financial conditions aren’t so tight by themselves. So it’s a bit of a mixed picture, but our assessment is overall financial conditions somewhat restrictive. But the question the Board faces each and every time they meet right now is, is it restrictive enough?

It’s certainly a tough proposition at the moment. I think one thing that surprised us a little bit more recently, particularly over the last two weeks, is market pricing for the cash rate here. So we have seen, in particular, post the labour force data last week with that lift in the unemployment rate to 4.7 per cent, that market pricing is, I would say, on the lower side for November and maybe for the cycle at the moment. How much weight do you place on market pricing, or is it something that you watch quite closely as a way to interpret what all of us in the room are kind of thinking around the RBA at the moment?

Yeah, because it’s tricky, and there’s a debate, very lively debate in the US at the moment with Warsh and his views. I think on the one hand, you can use it to the markets digesting a lot of information, and it might be telling you something about the assessment of how all that fits together for what it means for the economic outlook in Australia. So that’s one aspect.

The other tricky part to pull apart is they’re also thinking, how are we going to react, the Board at the RBA going to react in response to this data? So I think it is really important for us to look at for both of those reasons, including if, does the market have a reasonable understanding of this thing called the Monetary Policy Board’s reaction function.

And I think in the main it does. But as you say, it’s responding to the data flow, and it’s also responding very much to what’s happening offshore. We are a small open economy, and rates kind of easing back just a little bit in more recent weeks has been a theme not just for us, but for others.

Yeah. And as you say, it is hard also to understand how much of that’s getting influenced by offshore and how much of it’s getting influenced by the data here. So we find that tricky as well.

I might just get more into the plumbing of the financial system and then I think we’ll turn to audience questions. Can you take us through the rationale behind the new term repo facility that was just announced, given it’s still quite rare among other central banks?

So I think the starting point is to recognise, so before the pandemic and when we used to operate at a tight corridor system around scarce reserves, it was very common for us to have longer-term operations in our daily operations as they were then. From time to time, even in normal times, we would put up a term that was fairly lengthy. That’s because it suited our needs at the time. And then in times of stress, it was a mechanism to provide some calming noises to markets and to help the market in terms of its liquidity management. So we had done all of those things in the past, but in the past, all of our operations were auctions where price was something that banks competed on when they came to our auctions. Whereas now, under our ample reserve system, we have full allotment auctions at the seven and 28-day term. And they’re pointedly seven and 28, particularly not more than 30 days, because we don’t want to have an influence on banks’ LCRs.

But those are full allotment auctions. And we still think that it makes sense to be able to offer a sort of funding at longer terms, and in normal times, at really small quantities. So that’s the plan, but not to keep those quantities down, not to … We certainly don’t want to overly and adversely affect private markets. We want to keep those quantities fairly small. So that means having a price-based auction. And so we’ll be having this mix, full allotment for those regular seven, 28-day term OMOs, and then price-based auctions for those longer-term ones. And then in times of stress, people will be familiar with those differences and it won’t be such an operational difficulty for them to work out, "Oh, we’ve got to come to this term auction. We want funding at term. The bank’s offering more of it than maybe normal. How does that work?" So we’ll have these as a matter of course, just so people know how they work in normal times, and they’re ready to scale up if and when needed.

All right. Now, we’ve got two roving mics. Does anyone have a burning question in the room? Please feel free to pop your hand and we’ll get a microphone to you.

You mentioned the wealth effect and the transmission, and you mentioned the tax changes there has been. Straightforward question, I guess. Hasn’t the housing tax changes, the reduction in incentives there, done a lot of the RBA’s work already?

Well, it’s moving in the same direction as monetary policy, if that’s what you mean. I think it is hard to split them exactly, but this is, in terms of, say, the effect on investor credit, one of the larger moves in recent tightening phases. And that’s no doubt down to the effects of the tax changes and what it’s doing for investor incentives. So look, I think it’s in a helpful direction. I think that’s hard to argue with.

You’ve got a very large focus on capacity utilisation in the NAB survey and what your liaisons are telling you about capacity utilisation. When I look at capacity utilisation, it’s a threshold measure for inflation. It’s not a linear relationship. So if we look back at the last 20 years, prior to COVID, you had to go over 84 to see inflation lift on NAB’s measure, but let’s call it 82 and a half, 83. We’re sitting below that. So I know it’s above the long-run average, but the long-run average has never been indicative of inflation pressures when we look historically.

So why are you looking at that so much as a capacity problem? And why are we not looking more at profits in the NAB survey, which are deteriorating quite sharply and do have a nice lead on both employment and on inflation out of that survey?

Well, I think the NAB survey has always been valuable because it’s a very timely one. But I wouldn’t want to overstress that it’s the only thing we look at by any means, and indeed, that’s why we have the liaison program. So the profits can be weak exactly because supply, there are sort of significant costs that business are facing, and not just, say, on energy and oil related, but labour costs are running pretty strongly at the moment, and that’s an important cost. And that’s not so much a nominal wage story because nominal wages aren’t particularly out of line, it’s more about very weak productivity growth.

So look, I would say, like many things, it’s just one indicator. It’s one important indicator, particularly because of its timeliness, but we look at a whole range of those. And our liaison generally tells us that business are facing into a lot of these cost pressures, and their inclination is to be, where they can, to be passing those on, having faced these cost pressures for some time.

Might just ask one of the questions I’ve gotten here through Slido, and there’s actually a couple questions on the term premium, which shows you, I think, the interest in the audience at the moment. Now, one of the questions, and I know it was from someone anonymous, maybe didn’t want to put their name behind it, but what can address the rise in the term premium? Or do we need to address it?

What can be done? Is it a case of central banks need to take action to restore credibility? Is there something else to address the rise to, I guess, settle bond yields in the market?

I think in the main, it’s one of those things we just have to take as given that we can’t influence. I think we can have some influence on it. So if part of the concern with the term premium is, will central banks really get on top of their inflation mandates globally? Then that’s something central banks can obviously do something about. It’s not immediately clear that’s the case.

I know there have been concerns, and it was talked about in the prior session about the question about the independence of the Fed. I think the market’s largely put that to one side now, those concerns. So central banks can have some influence, otherwise, I think they just need to take it as given. And what the higher term premium means is that borrowers, both governments but also corporate sector, are facing into higher borrowing costs. So that’s a tightening of financial conditions by itself.

I think the one thing to recognise in Australia is that at the margin that has less impact here because so much of our borrowing, particularly in the private sector, is priced off the shorter end of the curve. So that’s through the cash rate, BBSW, three and six months, and the like. And yes, even corporates that issue bonds, they issue those at terms, but they’re for terms much shorter than the typical sort of 10-year term that people are focusing on when they talk about the term premium.

Although I would say there are, I think, a lot of challenges or rethinking from corporates here in Australia just around funding costs and particularly how under-hedged corporates have been recently just with that lift in the cash rate here. So it’s certainly top of mind for a lot of Australian businesses here. Were there any other questions from the audience right now? I see some hands up right at the back, if we can get some microphones out there.

Looking at the recent communication from the Fed and the ECB and even the Bank of England, they’ve taken a more measured approach with regards to inflation. Do conditions now warrant the same stance from the RBA given the current pressures you’re facing?

Can I ask you to clarify what do you mean by a more cautious approach to inflation?

In so far that they haven’t been so concerned about the knock-on impacts from the recent Middle East intentions onto current inflation indicators. They’ve been rising slowly, but they’ve not directly and explicitly addressing those, so probably right now.

Yeah. I’m not quite sure that’s how I’d interpret the ECB at least. I think they’re very much concerned about the potential for these so-called second-round effects from energy. They’re hit particularly hard, not just by oil prices, but the price of other energy products coming to them from the Middle East on which they’ve been quite reliant. So I think they have made some moves, and they have ascribed those to the concerns about inflation.

And I think that’s very much front and centre of many members of the FOMC and the Fed. I think what they’re trying to do is balance off those versus kind of making a judgment as to how tight labour market conditions and demand and supply are more generally. And one thing that the US has had in its favour is very strong productivity growth, so they haven’t had quite the challenge we might have faced here with very weak productivity growth weighing on the growth of potential supply.

I think there was another one at the back. I think there was another question at the back. Thank you.

You mentioned there the exchange rate channel, and that’s obviously been an important channel for the transmission of monetary policy for some time. But I note that you’ve sort of emphasised it there, as did Governor Bullock in her most recent monetary press conference. I’m wondering, why is this now a focus of the communications when I suppose this channel has always been at play through this cycle, and the Aussie was up above 72 cents earlier in the cycle?

I think it’s always been there. Doesn’t necessarily always get talked about or questions asked of it. What we always face and what the Governor faces into, particularly in her media briefings, is questions about the cash flow channel. Because they’re the very tangible one that people, everyone in Australia understands. Even if they don’t have a mortgage, they’ve had a mortgage in the past, or they would like a mortgage in the future, if they’re yet to get into the housing market.

And so they understand that channel. It’s very tangible. So I think it’s important for us to acknowledge that, including because for mortgage holders that are struggling and haven’t had a chance to build up those buffers they can rely on, that really is a painful experience for them. But then it’s important, I think, particularly on questions about is monetary policy working, you’re only doing this to mortgage holders, it’s important to talk through all these other channels.

And an exchange rate one is one that quickly gets forgotten by many, including those who say, for example, you may have heard the argument as much as I have, "Why is the Reserve Bank responding to high oil prices? We can do nothing to affect higher oil prices." Well, actually, we can because higher interest rates and a higher Australian dollar than otherwise reduces the cost of oil prices. Australians don’t pay US dollars at the pump for their oil prices. They pay Aussie dollars. So a higher exchange rate even has some effect there.

So I think it’s partly in response to these questions about the effectiveness of monetary policy, and it’s important to emphasise to people there are many channels, and the cash flow is probably the least important in terms of the macroeconomics.

I’m going to ask a question that’s come up a couple of times, both from me and also on the chat here. It’s just in response to the labour market data last week. So the unemployment rate came in at 4.7 per cent, which is certainly a little bit above, I think, where we, the RBA, and consensus had seen it for this part in the cycle. Certainly thought the unemployment was going to lift higher. Is there a risk that the labour market’s loosening a little bit quicker than what was expected? Or should we be cautious around that data print, just given the survey changes that have occurred by the ABS?

I’d always be a bit cautious about the monthly numbers. They’ve always been volatile, even putting aside these sort of questions about changes in the survey which have had effects of late. But even having said that, there are indicators where the labour market has become less tight a bit faster than we might have forecast. And I think a really important question here, is that because demand is weakening maybe a bit more than you might have thought for labour? Or is it because are there still these pressures in terms of costs of labour still rising too greatly?

And we’ll get a partial reading on that and an ability to update some of the estimates of things like the NAIRU when we get the inflation data for the important stuff next week. So you talked about markets having moved and responded, and that made sense, I think, in many regards, at least in terms of the direction when the labour market came out, was a bit softer than people had thought. Let’s see how they view also the inflation data, and it’s important to put those two pieces of the puzzle together. That’s what we’ll be doing when we update our forecasts.

I think we’re all keenly awaiting that third quarter inflation data out next week. It’s hard to believe that is only next week, and then the RBA meeting is in just over two weeks’ time. I’m conscious we have less than two minutes left, but I have a question at the front of the room, so this might be our lucky last. Thank you.

The rise in business credit demand and the- reflecting the strength of business investment in Australia, which you said is widespread, which I think is a very encouraging sign. Do you think that’s going to offset some of this productivity weakness that we’ve been seeing in the Australian economy, and that’s been holding us back? So, you have to be upbeat because in my old graphs I used to draw, there was a pretty strong link between business investment and productivity.

Look, one can hope. That’s part of the puzzle and the picture in terms of stronger productivity growth in the future is business investment. It’s not the only part, the sort of tangible investment in capital, building infrastructure, and so on, private and public. But it’s an important part. So let’s hope. And it is something I point to when people sort of ask these questions about things all heading in one direction. Let’s say they focus on the household sector. The business sector has got a degree of resilience, including their investment plans, and so far they’re holding up and pretty strong, as is business credit. But thank you.

Like most conversations these days, it always does come back to productivity growth. We are at time, so would everyone please join me in thanking Christopher Kent for his time today.