Shane Oliver's Insights

Source: RBA, AMP Capital

• Several things are worth noting. First the period of one for one moves in the standard variable rate and the cash rate over 1997 to 2007 was a bit of an oddity. Banks do not get the bulk of their funding overnight at the cash rate but from a whole bunch of other sources. Movements in these were sort of consistent with the cash rate over the 1997-2007 period so the cash rate was the key driver. Second, since the GFC banks have been trying to get more of their funding from bank deposits as it’s a more stable source of funding than say short term money markets. But it’s also more expensive. And to keep depositors on side banks have had to pay them more. So for example the deposit rate line in the chart is now above the cash rate when prior to 2008 it was mostly below. Thirdly, banks have also been under pressure from regulators to raise more equity from their shareholders and this is also more expensive (eg they have to pay a 6% or so dividend). All of which has pushed up the average cost of money the banks borrow relative to the cash rate so mortgage rates have not come down fully with the cash rate. At the end of the day it is a highly competitive banking market so those with a mortgage are free to call up their banks, threaten to refinance with someone else and ask for a better deal (who actually pays the standard variable rate of 5.2-5.3% now anyway?). Returning to the days where bank lending rates are regulated and banks resort to rationing the amount they lend based on useful things like “who the customer knows at the bank” would not be a bright move. The danger is that all the bank bashing leads to a weaker banking system in which we all end up worse off. Finally, the argument that monetary policy is no longer effective because of banks partial and out of cycle rate moves is ridiculous. As can be seen in the chart, the main driver of bank mortgage rates through the cycle remains the RBA via its cash rate.

• US economic data was okay with a slight rise in small business optimism and continued strength in job openings, hiring and people quitting for other jobs. The negative though was continued weakness in productivity growth which is an obvious outworking of strong jobs growth and soft GDP growth. Putting aside issues about whether growth is being understated on the back of cheap or even “free” technologies that are significantly enhancing are lives, low productivity growth adds to concerns that potential growth is lower than currently thought and flowing from this that normal interest rate levels are also lower. However, I suspect GDP growth and productivity will move higher in the year ahead as the detraction from US growth flowing from a rundown in inventories and energy investment have likely run their course.
• The US June quarter reporting season is now more than 90% done and indicates a clear rebound in earnings from their March quarter low. 78% of companies have beat on earnings and 56% have beat on sales, both of which are above normal levels. More importantly while earnings are down 2.7% yoy they have come in around 3% better than expected and are up about 9% on the March quarter low.
• Japanese data was a bit better with solid gains in machine orders and economic sentiment.
• Chinese economic activity data for July was a bit weaker than expected with a slight slowing in industrial production (from 6.2%yoy to 6%), retail sales and fixed asset investment and continued weakness in exports and imports. Its early days yet and recent floods may be impacting, but so far the data suggests that Chinese growth in the current quarter may be edging down to around 6.5-6.6% yoy. Meanwhile, although a fall in food price inflation saw CPI inflation fall slightly, producer price inflation is continuing to fade which is good news for nominal GDP growth in China.

• Australian data was a mixed bag with business conditions and confidence down slightly in July but remaining relatively resilient despite the political uncertainty at the time, consumer confidence up slightly in August to be around its long term average helped by the latest rate cut and housing finance up solidly again in June. The okay level of consumer and business confidence point to okay but not spectacular growth in the economy and the rise in housing finance tells us that overall the housing sector is still solid. In terms of the latter, it looks like investor lending is having a bit of a bounce after growth in the total bank book of lending to investors fell way below the APRA 10% limit, but it’s doubtful that investor lending will be allowed to pick up too far as there is a good chance that APRA will lower the 10% limit to around 7-8%.
• The Australian June half earnings reporting season has kicked off on a relatively ordinary note with so far only 37% of companies exceeding expectations (compared to a norm of 45%). However, 71% have seen their earnings rise on a year ago, 52% have seen their share price outperform the market the day results were released and 93% have either maintained or increased their dividends. It’s also still early days with less than 20% of results out so far.