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Interest rate cuts working for investor confidence – 15 August 2019

Australian Financial Review

Official interest rate cuts are having the right effect on the economy and investors have confidence monetary policy will steer the economy through shocks, according to Reserve Bank of Australia’s assistant governor Christopher Kent.

Dr Kent said in a speech Tuesday morning to the Finance and Treasury Association that the transmission of monetary policy – which so far has included 50 basis points worth of cash rate cuts in Australia – was working as “usual” with data sets showing reductions in housing loan costs were clearly being passed on.

“The transmission of monetary policy in Australia to financial conditions is working in the usual way,” Dr Kent said. He said the change in the stance of policy had contributed to a decline in the cost of funding in corporate bond markets as well as having supported equity prices, lowered the value of the Australian dollar and lowered the cost of funding for banks, businesses and home loan borrowers.

“Much of the reduction in banks’ funding costs has been passed through to business and household borrowers,” he said. He noted the average interest rate actually paid on outstanding variable-rate housing loans in the Reserve Bank’s securitisation data set decreased by 23 basis points in June and that this was the same average announced reduction in standard variable rates by banks.

“Similar reductions in outstanding rates are expected to be recorded for July data.”

He noted that new borrowers, and those refinancing existing loans, continued to be offered interest rates that were on average “well below those applying to existing loans”. “So customers who are actively looking around at what’s on offer, are able to take advantage of the strong competition among lenders.

“Although housing credit growth declined further in June, approvals for new loans increased. This increase in approvals was broadly based, across owner-occupiers and investors, across states and across different types of lenders.”

Investors have confidence in central banks

Dr Kent also pointed to corporate bond markets as another area where investors were showing confidence that monetary policy transmission effects were working.

“Corporate bond yields have declined this year. One possible interpretation of the low level of corporate bond spreads is that investors’ concerns about corporate defaults are about as low as they have been for quite a few years.

“That is somewhat at odds though with significant concerns about downside risks to global growth. So it’s possible that market participants are placing considerable faith in the willingness and ability of central banks to respond to adverse shocks.

“Market analysts still expect good growth in earnings next year, despite some slowing in earnings growth this year and notwithstanding rising downside risks to global growth.

“Again, this suggests that participants judge that adverse shocks to growth are either likely to have only a modest effect on corporate earnings, and/or that policy accommodation will help to mitigate the effects of any adverse shocks to growth.”

Dr Kent’s comments go some way in explaining the apparent contradiction between rising stock markets but expectations of lower interest rates, which  Reserve Bank governor Philip Lowe said he did not understand earlier this year.

Dr Lowe said in June that investors who think the outlook is sufficiently weak expect central banks around the world to cut interest rates but they were also not worried about corporate profits or credit risk. “I don’t really understand that,” Dr Lowe said.

Dr Kent also warned that asset prices could also take a hit if trade war tensions continued.

“As seen during the recent ratcheting up in the US–China dispute, asset prices could fall quickly if market participants become more concerned about its potential to weigh on growth of the global economy and corporate earnings.”

He also noted that in trade-weighted terms, the Australian dollar had declined by about 7 per cent over the past year or so and is now lower than it has been for many years.

“There has been a noticeable decline in Australian interest rates relative to those of major advanced economies.

“At a two-year horizon, this interest rate differential has declined by about 100 basis points over the past year. This lower return on Australian assets would no doubt have contributed to a decline in the value of the Australian dollar.”

 Article appeared in The Australian Financial Review on 15 August 2019.

Article written by Matthew Cranston. 

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