The Reserve Bank of Australia provided one of the strongest hints that the cash rate may not go further down from here, saying it remains unclear if a shortfall in demand can be made up quickly through monetary policy action.
The hint was delivered by Governor Glenn Stevens in his opening statement to the House of Representative Standing Committee on Economics in Sydney and later while answering their questions.
Stevens said monetary policy is very accommodative and based on current indications, the RBA expects to keep the cash rate stable for a while.
He admitted "the outlook contains many uncertainties, not least the 'hand over' from mining investment spending to sources of demand outside mining," even as there are signs that handover is happening.
"The question then is: will the additional demand likely to be generated outside mining as a result of these trends be just the right amount to offset the large decline in mining investment spending, so keeping the economy near full employment?"
But even if there was a shortfall in demand, Stevens said, it "could not be assumed that a shortfall in demand could necessarily be made good in short order by monetary policy. Monetary policy can have a powerful effect on the general environment, but it cannot hope to fine-tune the quarterly or even annual path of aggregate demand,"
Later Stevens repeated he expects the cash rate to remain stable for some time but added the RBA hasn't specified "how long" the cash rate will remain stable because "I don't know."
The guidance to keep the cash rate stable for some time is a change from the previous signal there could be a scope for easing, Stevens said. But the change indicates that based on the current outlook, the RBA doesn't see scope for more easing, even as he emphasized that the guidance is based on "current indications" and could change if the outlook changes.
In short, Stevens seemed to suggest there was no scope to lower the cash rate further based on the current outlook but even if the outlook didn't come to pass as the RBA now forecasts, there isn't much scope for monetary policy to step in and make up for the shortfall in demand.
At the same time, Stevens provided no hint that the RBA was in any rush to raise the cash rate.
He said the unemployment rate is expected to drift higher in the quarters ahead. Asked specifically on how much the labor market lags the growth in the economy, Stevens said it may be "one or two quarters."
Assistant Governor Christopher Kent elaborated on the labor market, saying "roughly speaking, we see the unemployment rate drift up a little bit from here, but probably sometime early 2015 peak and stay there for a while."
An improvement in economic growth is not likely to make inroads to the labor market until late 2015, Kent said.
On the housing market, Stevens didn't show any discomfort with the rise in prices or the increase in buying interest from overseas investors.
Stevens said foreign investors have a role to play in the housing market. "In a way, we tend to feel we want to be open to foreign investment.. this is a form of that."
Stevens said foreign investors were buying new structures as it is easy for them to do this. "If there was a supply side constraint, the issue is worth addressing. Beyond that, the question is how welcoming we want to be... this is a matter for the Parliament to manage."
On the effect of restrictions in Canada on the housing market here, Stevens said there will be some effect but "I cant quantify the extent of spillover in our direction"
But if house prices continue to rise further, would the RBA consider macro-prudential tools, Stevens was asked.
Stevens said he has previously stated the RBA has had preliminary discussions with the prudential regulator about macro-prudential tools for housing. While he recognizes such tools are useful, he said, "we should use them with a bit of realism."
Deputy Governor Philip Lowe also said macro-prudential tools can be useful but can also create distortions, especially harming first-home buyers when tools like a cap on loan-to-value ratios are used.
A better tool would be tighter lending standards, where a home loan application is tested for scenarios of 300 basis points higher interest rate than around 200 basis points as is currently donr, Lowe said. This would be more useful than raising the cash rate as current mortgage borrowers and other sectors of the economy could continue to enjoy the benefit of lower rates.
On inflation, Stevens said the higher-than-expected fourth quarter inflation data may have contained both noise and signal for future inflation. But the RBA's overall assessment is "that inflation is not quite as low as it might have looked six to twelve months ago, but nor is it accelerating to the extent a literal reading of the latest data might suggest."
Still, the RBA's view remains that the "outlook for inflation, while a little higher than before, is still consistent with the medium-term target," Stevens said.
Stevens said monetary policy is very accommodative and is doing the sorts of things that is normally expected to result from low interest rates, including promoting a rise in asset prices, construction of dwellings and depreciation in the exchange rate.
However, he added, the exchange rate "is still high by historical standards."
Later, on a question on the meaning of "jawboning" that the RBA is said to be doing for the exchange rate, Stevens said they refer to the fact that "we made remarks about levels of exchange rate" and the assumption is "these remarks were made in an effort to move it."
But Stevens said jawboning has a limited effect in lowering the exchange rate and in theory a central bank could take other steps like intervening in the foreign-exchange market or lowering the cash rate in an effort to bring the exchange rate down.
On the current level of the exchange rate, Stevens said his view is unchanged from that expressed in an interview with the Australian Financial Review newspaper back in December.
He said, "($)0.90 or higher is rather higher than any plausible assessment" of the economy.
In the AFR interview, Stevens had said: "I don't think the extent of our knowledge about what's correct is that good, but I did think ($0.95) was rather too high. I thought ($0.85) would be closer to the mark than ($0.95) at the time we started to make some comments some months ago, but, really, I don't think we can be that precise."
"I just think that if things over the medium term evolve as we're presently assuming - and I think it's reasonable to make these assumptions - it's going to be surprising if a nine at the front is the right number."
A high school student asked Stevens a question on what policy step he would take if inflation rises above the target band and the unemployment rate also rises to, say 7%. Stevens said it depended on what caused that combination but if inflation was higher, he would focus on the outlook for inflation.
"I hope the combination remains hypothetical," Stevens said.
On a question on where future growth in the economy would come from, Stevens said the mining sector is likely to contribute positively to growth in to the long run, after the initial downturn in the near term. But based on history, it is likely the economy will evolve in the direction of services.
"That's where most opportunity lies, included trade in services," Stevens said.
Steven was asked his view on the U.S. Federal Reserve's tapering plans. He said he believes that a "fair bit" of weakness in the labor market may be needed there for Fed to change its path on tapering.
He reminded that even with tapering, the Fed's balance sheet is still expanding, so in effect it is "still easing monetary policy" but easing at a slower pace.
A question was asked about monetary policy comments made by RBA board members to which Stevens replied he's the only one authorized to speak on behalf of the board. He admitted the RBA can't stop board members talking about things they know about, including in their own field.
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