What the RBA thinks about the economy

ABC Listen, podcasts, radio, news, music, and more. You've watched the news and think, "Whoa, this seems unprecedented." "Unprecedented?" "It's unprecedented." "This has never happened before. This is unprecedented." I'm Matt Bevan, and my show, if you're listening, is about finding times that what's happening now has happened before and figuring out what we can learn from it. Starting from history, I mean, who could imagine? New episodes every Tuesday and Thursday on ABC Listen, or wherever you get your podcasts. It's official. The Reserve Bank has held the cash rate at 4.35%. That's a decision in line with most economists' expectation and the market pricing. But how does this hold fit into the Reserve Bank's view of the wider economy? Is it a sigh of relief from the board members? Or are they watching risks and thinking that they may have to move rates higher again? Welcome to ABC Business Daily. I'm Michael Yandin. And I'm in Vierna of the ABC's Chief Business correspondent. So Ian, we've just been locked up for a bit over an hour and a half. We've read roughly 60 pages of RBA forecasts and commentary. We're just looking out here at the RBA's temporary office in the city at the Harbour View, while they rip the Asbestos out of the old office in Martin Place. We've had a few sandwiches courtesy of the RBA, so thank you very much, Michelle. Little bottles of water ready to go to have our chat. And I guess I have to start off with, were you at all surprised that the Reserve Bank kept rates on hold this meeting? I would have been stunned if it was any other decision. I mean, there was no way they were going to cut interest rates at this point in the cycle. And the way the economy is travelling at the moment dictated really that they had no option, but to sit on their hands. I mean, we've had three rate hikes this year already. They've only just really started to kick in to have an impact on the economy. And we've seen some fairly dramatic shifts in the way the economy is performing as well, which would really dictate to the board of the Reserve Bank that they need to hold for a little bit further. Yeah, I mean, those inflation figures that we saw come in well below expectations. The jobs market's been a bit here and there. Some stronger than expected figures after some weaker than expected ones. No signs that consumers are racing out to the shops. In fact, some more recent signs from some of the retailers that actually people started shutting their wallets in May. So the market pricing was probably pretty spot on that there was something like a 3% chance of a rate rise ahead of today's meeting. So it transpires that they did nothing. But what we do get after the meeting, which I'm just looking at on my laptop, because we don't actually get it during the lock up. We don't know what the other decision is. And we don't get to see the board's post meeting statement, because that would reveal what the decision had been. But they've kind of softened their language. In the last, the crucial last sentence, they say the board will be attentive to the data and evolving assessment of the outlook and risks to guide its decisions. Monetary policy is well placed to respond to developments, and the board is focused on its mandate to deliver price stability in full employment. To me, that sounds like a reserve bank that has moved from being very much on the side of further rate hikes to one that now sees itself as neutral rates could go either way. And you've seen that evolve over the last couple of months. And in the private sector as well, all the bank economists have all softened their approach. And look, we've still got an inflation problem here. And it's not one that resolves itself until, well, really, well into next year. If you just go by the inflation numbers, the trim to mean inflation, which is one of the reserve bank looks at. So what are we looking at here? What has been the factor that has swayed them in for my thinking? It's the property market. Yep, the housing downturn, because I mean, Michelle Bullock will tell you till she's blue in the face, and I'm sure she'll be asked at the press conference. I hope you know that. About the housing market. But her answer is always, we do not target house prices. The reserve bank does not target house prices, which may strictly be true. But house prices are such a crucial factor for the economy. I mean, you wrote about that this morning. Yeah. You know, it's really interesting until about 30 years ago, right? Property prices, real estate, and mortgage repayments in particular were part of the consumer price index, okay? But the reserve bank had it removed from the consumer price index. I can understand why, because if we had an inflation problem and they raised interest rates, mortgage rates would go up, and therefore people would pay more, which would look like it was being more inflationary. And I actually asked Michelle Bullock at her most recent speech in the Q&A about that, you know, many people think that the reserve bank is contributing to inflation by making mortgages more expensive. And she said no, right? No, because they're not real pricing crisis. Because they're not in the consumer price index, because the reserve bank had it removed. I mean, like I said, I can understand why, because if they raised interest rates during a period of high inflation, what you'd do, you'd push up mortgage rates, and that would make the problem look even worse. And on the downside, if the economy was slowing, and you can't interest rates, and mortgage repayments fell, it would look like the inflation was declining at faster than is. So they've tried to cut their own contribution to the problems of the economy out of the equation. But by doing so, it's given a lot of economists this idea that, well, housing isn't really crucial or vital or even, you know, marginally important when it comes to setting interest rates, when in fact, it very much is. Well, interest rates have the most direct effect, because of the predominance of variable rate mortgages that change within months of the reserve bank shifting rates. Well, within, you know, sometimes minutes, the banks have announced their response within a week or two, the additional interest if rates have gone up, gets added to your calculation of how much you owe the bank. The minimum repayment you owe the bank may not move for two or three months. But compared to a lot of other countries, the pass through from interest rate rises in Australia is so much quicker because of the housing market and big debts and variable rates. Australia has, we are the most sensitive country in the world when it comes to interest rate hikes. Which is why we're sitting here talking about it, because it's what everyone wants to know about. Right, so, I mean, you know, if you're in America, you might decide you won't buy a house this year because interest rates have gone up. But if you're already owner house, right, it doesn't have an impact on you whatsoever. It impacts your decision about whether you will buy a house in the future and lock in a 30-year home loan. But here, you know, it comes directly out of your budget, out of your hip pocket, you know, every, every week, if you fought night. Now, you mentioned there that probably, and we get the chance to have a background not for attribution, not for quoting briefing from the Reserve Bank's Chief Economist Sarah Hunter just to walk us through what is in the document. So, we're not getting any extreme information, but it just helps you find what's there. And one thing that she pointed us all to in the room is the risks in the document. That the Reserve Bank's always looking at the risks to their forecasts, and we'll get into what the forecasts are. The downside risks to inflation is, as you say, the housing market, because they've put forecasts in, and they're not sure if they'll be right or not, you know, it's a nature of forecasts. If the housing market declines more than the modest amount that the Reserve Bank's expecting, then inflation might fall a lot faster and further. And then we'll be talking about rate cuts sooner. The interesting thing to note, though, is the list of risks from the Reserve Bank's Economics Department on the upside, where inflation might come in higher than their forecast, was a lot longer. I mean, we had inflation risks from the global economy growing more strongly than expected. Inflation risks from the Middle East conflict, which is still not resolved, and which could see oil prices spike again above $100 US dollars a barrel. And it still takes another year or two for the full pass through from oil price spikes to get through the economy. So, the Reserve Bank's watching that. They're watching limited capacity in the economy, because productivity growth was even worse than their already low expectations. In fact, it went backwards. And market services inflation, that's domestic inflation, basically, when you go to a cafe or restaurant in aged care, in health care, in education, that was also much higher than the overall measure of inflation, which has the Reserve Bank worried. And then add into that, we're going into what is potentially one of the worst El Nino's we've had for a long time. So, that was came out of the blue really. I didn't expect them to highlight that to the extent that they did, but it will result in higher food prices, not just for Australia, but globally. environmental impact from a weather event that really hits cropping and hits its volumes, then that will push up global food prices. But then there's the big one, artificial intelligence. And there is a lot. I mean this is a good segue to get into the statement on monetary policy which we spent a long time reading today. And there was one number in the Reserve Bank's most recent forecast, much more than any other number that really was shocking. In a positive way in many senses, but it was business investment. And in this case, you know, 15 years ago, business investment equaled the mining boom and mining investment. Now when the Reserve Bank talks business investment, it's talking data centers and the AI boom. And it is forecasting that for that, well, it expects for the quarter that just ended that business investment will have grown six and a half percent over the year. That was 2.6 percentage points higher than its previous forecast, which is only three months old. And then for the end of the year, it's expecting growth of 4.3 percent. So a little bit slower, but that was revised up by three and a half percent from the previous forecast. And these upward revisions keep going for the next year after that. So the Reserve Bank is saying that even in the past three months, it has massively underestimated just how much money is being spent on building new data centers. Well, there's been a rush. I mean, you know, just in the past few months, we've seen the chief executives from, you know, some of the world's biggest tech companies, lobby into Australia, you know, basically trying to drum up support from the government, from business leaders from everybody, trying to do real estate deals, just trying to get these things built and built as quickly as possible. Yeah, and regardless of the cost. So cost is a second order issue. Don't worry about how much it's going to cost. Let's just be first. Yeah, I mean, and this goes to the labor, skilled labor crunch in the construction sector. So the government's here trying to build 1.2 million new homes over five years. Yeah. You know, state governments are trying to build the infrastructure to actually transport those people around and give them healthcare and education, which, you know, an announcement of a new public school in Sydney for, you know, in an area that hasn't had a new one since they closed the last one in the 80s. All these types of things, but at the same time as all these construction workers are needed, the big multinationals are coming in saying, no, we'll pay you whatever to get an electrician to come and work on our data center. Well, I mean, what is a data center? Essentially, it's a massive shed. It's just a gigantic shed, right? Covenant solar panels. Yeah. Covenant solar panels and full of electronic equipment. And I guess the downside to this boom, because it is a construction boom, the downside of the boom is Australia doesn't produce any of the gear that is going to go inside these things. All of that will be imported. So we're building the sheds. Yeah, we're building the sheds, but we're installing all of that equipment. And the installation of that equipment is going to require a hell of a lot of highly skilled labour electricians. I don't know what they're called. I.T. professionals. Yeah. And that labour has to come from somewhere, which could be one reason why the unemployment rate hasn't risen as quickly as some thought it would have, although interestingly in the forecast, again, going back to the statement on monetary policy, it has risen a little more than the reserve bank was expecting. So that's probably another factor that's allowed them to be a bit more neutral in their statement and outlook for interest rates. And another one that has is household consumption, which has been revised downwards this year as the effect of those rate rises start to hit home and also the loss of confidence from the Middle East War. And in some ways, you could argue that households are being squeezed by the reserve bank through interest rate rises to make room for this massive private sector investment in data centres on the one hand and then a continued upgrade in public spending forecasts, which we also saw in this statement on monetary policy. Yeah. And I mean, look, one of the interesting things about household consumption is that it has actually stayed relatively buoyant considering that the surveys of consumer confidence had been at all-time lows. So there's a little bit to try and unpack there. Perhaps one of the things is that during the worst of the fuel crisis, we did see some government subsidies come, it will not so much subsidies, but they took the tax off fuel, some of the excise tax, and that has helped to smooth out some of the worst of the problems from that era. So what we're seeing now is spending shifting from the government back onto the consumer. So it's kind of smoothed it out a little bit. Yeah. And in some ways, it may not have done what some economist feared, which is spark putting more money in households pockets and sparking more consumption. In some ways, what it may have done is take some of the edge off fuel prices so that the pass through domestically from the global oil shock hasn't been as big as the reserve bank feared. In which case, that will have been what Treasury would have been hoping for it to do. Yeah, and look, there's a couple of interesting things in this whole episode, really. And I mean, one is, I'm old enough to remember the oil shocks of the 70s, and they were devastating, absolutely and utterly devastating to ordinary people, because fuel prices just went through the roof. This time around, you have a much different kind of reaction. We've had huge supplies globally that have been run down, which have helped keep prices fairly much in check, not the runaway kind of price story we saw back in the 70s. And we actually had a bit of a glut of production going into the Middle East conflict. And plus, we've got this whole electrification of the economy globally, but particularly in Australia in happening. And that is helping to essentially smooth out this process. You've got a huge spike in electric vehicles. Now for the demand for them. So a lot of Australians are just switching away from fossil fuels into electricity. Big spike in battery installations with the government scheme, and also after the big power price increases post-COVID. And we had a foretaste of this with the Ukraine energy shock. So I think already a lot of households and businesses were coming into this forewarned and forearmed that this was a risk. And of course, energy prices are a major contributor to what is at the heart of all of this, which is inflation, which is what the Reserve Bank targets. It wants to get it back to the middle of its 2% to 3% target band. It expects in these latest forecasts to get it back to 2.5% by the beginning of 2028. So I guess the key question there is, is that quickly enough to keep the hawks on the Reserve Bank board happy? Probably not, but what's the alternative? Because what they've seen here is a drop-off in housing in the housing market that is much more severe than they anticipated. And they mentioned it several times in this document, the statement of monetary policy, that the downturn in the property market has been a lot swifter and a lot more broader than they had anticipated. So in many ways that housing downturn due partly to the Reserve Bank itself and its three interest rate rises already this year and partly due to the tax changes around property that seem to be having an impact on investors already in the market may forego the need for any further rate hikes and may even get us into a rate cutting cycle more quickly than people had thought. Well one thing you really got to be careful of, and especially if you're a central banker is you don't want to create a housing market collapse. We've seen over history, fairly recent history what happens when you do spark that and it can get very ugly. You've only got a look to China from about 2019. If you go back to the global financial crisis that was a property crash that began in America and then you look at Japan back in the 1980s and they deliberately engineered a property market crash which they're still recovering from. So that is the Reserve Bank of course they don't consider property one little bit. That's front and center of their calculations I think. And if anyone hasn't read it already you can find Ian's fantastic analysis piece from this morning that goes into that relationship between housing and interest rates on the ABC website. But Ian I probably need to let you go. I'm running back into the office to write some more analysis around the actual decision. And I'm running into the press conference with Michelle Bullock. Yes and if you arrive late they lock the doors. I know I found out last time. So we'd better let you go. That's it for today's episode of ABC Business Daily recorded down here at the Reserve Bank's temporary headquarters. We'll be back with another episode of Business Daily tomorrow. Make sure you're following us on ABC Listen or wherever you get your podcasts. And if you'd like to ask a question send an email to ABC Business Daily at abc.net.au. Catch you later Ian. So yeah.