A key reason i do not think the RBA will ease their policy rate at their May meeting is that the housing market is turning up. Just the day before the Q1 CPI report was released, Luci Ellis (Head of the RBA’s Financial Stability Department) was at Citi giving a speech entitled Housing and Mortgage markets.
This speech included a section on the monetary transmission mechanism (of which housing is a key part). Luci noted that it is common to hear scepticism about policy’s efficacy at this point in the cycle, but that they were seeing signs that they had traction.
Interest rates have been lowered quite a bit over the past year and a half or so. As so often seems to happen, soon after a period of easing we start to hear concerns that monetary policy might not have any effect this time, because of some special factor interfering with normal relationships. After a period, though, the signs start to emerge. Typically, financial variables like credit and asset prices respond first. Output and inflation adjust later, the well-known ‘long and variable lags’. Recent data have followed precisely this pattern: monetary policy still works. Equity markets are up, and so are dwelling prices (Graph 10). Credit growth has remained quite slow, but loan approvals to investors and existing home owners have been picking up for a while.
My read on this is that the RBA judged that they had gained decent policy traction, and could expect their prior policy easing to further add to demand in the future. The change in house price dynamics (they were falling a year back, and are now rising) seems to be a key part of this judgement.
This is stage one of monetary easing – the easing of broad financial conditions. The RBA’s finger prints are on the house price part of this; the world’s major central banks (ECB, Fed and BoJ) own the equity market re-rating — i think the RBA would have already cut further if not for the equity market re-rating that began in mid 2012.
By the way, the change in domestic house prices over 2012 suggests that the RBA was still tight mid year when policy was 4.25%. Looking back, neutral seems to have been ~3.5%
So now on to stage two – real activity. Again, it is common to hear that this time it is only going to be asset prices – like future consumption can rise indefinitely without any impact on current consumption. I don’t buy that, and we are seeing some signs of a pickup in housing activity.
That depends on how quickly we lose demand from the mining investment boom.
This is why i think the RBA will hold policy steady in May – they are awaiting more information about the likely evolution of mining investment demand. They don’t want the housing market to be too strong too early – as that might create other troubles (either inflation or financial stability) down the track.