Statement on Monetary Policy – November 20241. Financial Conditions

1.1 Interest rate markets

Advanced economy central banks are reducing their policy rates to less restrictive levels as the outlook for inflation improves and risks to labour markets and activity come to the fore.

Most central banks, including the US Federal Reserve (Fed) and European Central Bank (ECB), have decreased their policy rates by at least 50 basis points from their recent peak levels. These central banks have more confidence that inflation is sustainably returning to their targets – with some now concerned that inflation will fall below target – and have placed more weight on the outlook for labour markets and economic growth. Some central banks have adjusted their policy rates by less (Bank of England) or are yet to cut (Norges Bank), citing risks from persistent inflation and the need to sustainably return inflation to target in a timely manner. All central banks consider their policy rates to be restrictive, except for the Bank of Japan, which has said it expects to further increase its policy rate if the economy evolves as expected.

Central bank commentary on the pace of cuts has reflected the evolving assessment of local economic conditions. Fed policymakers have emphasised a more gradual approach to further cuts of late following the release of stronger-than-expected September employment data as they assess the balance of risks to achieving their dual mandate. Several other central banks have either increased the pace of easing or signalled a willingness to do so (ECB, Bank of Canada, Reserve Bank of New Zealand, Riksbank) in response to weakening outlooks for growth or strengthened confidence in timely disinflation. Differences in monetary policy strategies and remits across central banks (e.g. whether these include employment objectives) may also be contributing to variation in the pace of cuts in some cases. Some central banks are cutting faster as headline inflation approaches their targets; others have moved more slowly, emphasising more gradual declines in underlying inflationary pressures.

Market participants’ policy rate expectations have declined in most economies since the August Statement. Policy rate expectations were sensitive to both upside and downside surprises in the US labour market data over this period. While influenced by these US developments, policy rate expectations in other economies have generally declined reflecting unexpected weakness in some inflation and economic data and associated shifts in central bank commentary; Australia a notable exception (Graph 1.1).

Market expectations for the path of the cash rate in Australia are a little higher since the August Statement.

Market participants see little chance of a near-term reduction in the Australian cash rate, following the release of the September labour force data and a recent increase in Fed policy rate expectations (Graph 1.2). This increase has more than offset a shift down in expectations following the Governor’s September media conference, which revealed that the option of a further increase in the cash rate was not explicitly considered by the Board. The policy rate in Australia is now above those of several advanced economies.

A gradual reduction in the Australian cash rate is expected to begin around mid-2025. Market economists expect an earlier reduction in the cash rate than implied by market pricing, with easing beginning in the March quarter of next year.

The cash rate is estimated to be above the RBA’s range of estimates of the neutral rate, consistent with other indicators pointing to restrictive financial conditions.

The cash rate is also above market economists’ estimates of the neutral rate (Graph 1.3). Even so, estimates of the nominal neutral rate are subject to considerable uncertainty and are sensitive to the models and assumptions used, including those about inflation expectations. Moreover, the perceived stance of policy goes beyond simple comparisons of the current policy rate with the neutral rate; it also involves expectations about how policy will react to evolving economic conditions. Those expectations in turn influence longer term interest rates and broader financial conditions, and the behaviour of households and companies.

Estimates of the neutral rate have increased since the pandemic. This is a trend also seen in some other advanced economies and reflects a range of drivers affecting saving and investment trends, including growth, demographics and governments’ fiscal positions. However, there is substantial variation in estimates across countries, so country-specific factors are also influential. Frictions in global capital markets could mean country-specific savings and investment trends will affect the neutral rate in that country, along with country-specific premia and spreads. Also, different inflation targets will translate into different estimates of nominal neutral rates.

The gap between policy rates and estimates of neutral (shown in green in the graph below) remains smaller in Australia than for central banks in most other advanced economies, despite many other central banks cutting rates multiple times (as indicated in blue). Market participants expect that to change over the next year, with pricing implying a more rapid easing for most other central banks. Markets expect policy rates in most advanced economies, including Australia, to converge to around central bank estimates of neutral levels by the end of 2025 (as shown by the orange dots) (Graph 1.4).

A comparison of key financial indicators in Australia against historical averages shows that conditions faced by the household sector (shown in orange text) are tighter than those faced by businesses (shown in purple text) (Graph 1.5). The financial indicators are discussed in more detail below. The Board reviews a broad set of economic data and the outlook for that data to determine whether financial conditions are restrictive enough to return inflation to target in a timely manner.

In contrast to near-term policy rate expectations, longer term government bond yields in most advanced economies have increased since the August Statement.

The rise in longer term yields may have been driven in part by perceptions among market participants that a soft-landing scenario is increasingly likely. The rise has also been driven by upward pressure on term premia and long-term market-based inflation compensation associated with geopolitical tensions and uncertainty about future US trade and fiscal policies following the US election (Graph 1.6; Graph 1.7). This uncertainty may persist, as it could take some time beyond the election to understand which policies will be implemented and what their ultimate impact on markets and the global economy will be.

Yields on Australian Government bonds have also risen in recent months. Indeed, spreads between Australian and most overseas government bond yields are near their highs for the year.

1.2 Other measures of financial conditions

Prices of riskier assets have generally increased in advanced economies since early August.

Equity prices in most advanced economies have increased since early August (Graph 1.8). The rise in equity prices over this period has been driven by an increase in expectations of future earnings in the United States and a decline in equity risk premia in Australia and most other advanced economies. Consistent with developments in interest rate markets, this suggests market participants see a soft landing as more likely than they did previously and, following some robust US labour market data released in October, attach a lower probability to a severe downside economic scenario. Australian mining companies’ equity prices increased following the announcement of the Chinese policy stimulus package, though this has since partly unwound.

In early August, a bout of heightened volatility followed the release of weaker-than-expected US economic data and was amplified by the unwinding of leveraged trades and seasonally low market liquidity, with Japanese equities experiencing their largest ever three-day fall. The subsequent rebound in equity prices has encouraged leveraged investors to partly rebuild positions, which could again exacerbate volatility in response to further economic shocks. While this episode highlighted that markets can recover quickly in the absence of further adverse shocks, expected equity price volatility in the United States, Europe and Japan remains above the low levels of earlier this year, but below the long-term average. By contrast, expected Australian equity price volatility has declined back to around the low levels seen earlier in the year.

Corporate bond yields in the United States and Europe have generally declined since the August Statement (Graph 1.9). Spreads on corporate bonds have narrowed over the same period, reaching their lowest level in the United States in more than 15 years. Spreads on sub-investment grade debt have narrowed notably, consistent with strong investor demand and increasing confidence among market participants of a benign credit outlook. In Australia, spreads on non-financial corporate bonds have been little changed and are near their lowest level since early 2022.

Corporate bond issuance in the United States and euro area has increased of late to around or above average historical levels, with some market reports suggesting US companies have brought forward issuance to avoid potential market volatility around the upcoming US election. Issuance by Australian non-financial corporations has been strong since early this year, with liaison contacts citing continued strength in investor demand as a driver.

In China, financial markets have reacted positively to the announcements of further macroeconomic policy support, though long-run challenges remain.

Authorities have shifted their policy stance notably with a comprehensive package to support economic growth and address some vulnerabilities (see Box B: Economic Policy Developments in China). Equity prices increased by more than 30 per cent following recent policy announcements, as investor risk sentiment improved (Graph 1.10). However, equity prices remain well below levels of earlier years, and have been volatile of late as markets await further details of the fiscal stimulus package. Property developers’ asset prices have risen sharply from very low levels but continue to reflect severe financial stress in the sector. It is unclear if the announced measures will stabilise property sector conditions, with weakness in the sector continuing to weigh on broader economic activity and credit demand despite further monetary easing by the People’s Bank of China.

Chinese Government bond yields have risen a little from recent lows, supported by an improved economic outlook and expectations for additional bond issuance to fund fiscal stimulus. Some of the additional bond issuance will be used to address local government debt problems that have been exacerbated by property sector weakness and weighed on bank profitability. The Chinese renminbi has appreciated modestly but remains close to its recent lows.

The Australian dollar trade-weighted index (TWI) remains within the range observed since early 2022, as the effect of a rise in yield differentials has been offset by uncertainty around the US presidential election.

The Australian dollar TWI is around the middle of the range observed since early 2022 after nearing its year-to-date low in early August amid the liquidation of positions related to Japanese yen carry trades and a deterioration of risk sentiment. The small appreciation since then reflects higher yield differentials between Australia and other major advanced economies, as market participants continue to expect policy easing by the RBA to be later and more gradual than in other major advanced economies. An improvement in the outlook for the global economy also provided support, as concerns about a US recession abated and Chinese authorities announced stimulus measures. However, the risk of the United States placing significant tariffs on Chinese exports following the US presidential election has weighed on the yuan and tempered the appreciation of the Australian dollar; China is Australia’s largest trading partner with a 30 per cent weight in the Australian dollar TWI (Graph 1.11).

In real terms, the Australian dollar TWI has appreciated marginally over the December quarter to date and remains close to the model estimate implied by the long-run historical relationship with the forecast terms of trade and real yield differentials (Graph 1.12).

1.3 Australian banking and credit markets

Banks’ funding costs have been little changed and wholesale funding market conditions remain favourable for financial institutions.

Banks’ estimated funding costs are little changed recently, with small changes reflecting movements in bank bill swap rates (BBSW). Since the start of the tightening phase in May 2022, funding costs have increased by around 385 basis points alongside the 425 basis points increase in the cash rate.

Bank bond spreads relative to the swap rate – a reference rate for the pricing of securities – have continued to narrow following market volatility in early August and are now around their tightest level since early 2022 in the domestic market (Graph 1.13). Conditions in the Australian asset-backed securities (ABS) market – a key source of funding for non-bank lenders – continue to be very favourable for issuers. Year-to-date issuance is at a post-GFC high and spreads remain quite tight across ABS markets.

Borrowing at the RBA’s open market operations (OMO) has again helped alleviate quarter-end tightness in short-term funding markets.

Yields in short-term funding markets increased slightly towards the end of the September quarter. Banks responded to this by increasing the amount of Exchange Settlement (ES) balances borrowed at OMO, as they did during the June quarter as the Term Funding Facility ended. The borrowing from OMO has been recycled into short-term markets, helping reduce borrowing pressures. ES balances have remained little changed since the middle of the year (Graph 1.14).

Average rates on outstanding mortgages and deposits have been little changed in recent months, despite decreases in some advertised rates.

Average outstanding and new variable mortgage rates have been little changed over recent months (Graph 1.15). Rates paid on most outstanding deposits have also been little changed. Since August, several banks have reduced their advertised rates for fixed-rate mortgages and some term deposit products in response to lower benchmark (swap) rates; these changes have not had a material effect on overall household financial conditions as they affect only a small share of total lending and saving. The fixed-rate share of new lending increased in September but remained low at 3 per cent, while new term deposits comprise just 5 per cent of total deposits.

Financial conditions remain restrictive overall for households, but household credit growth has increased further.

Scheduled mortgage and consumer credit payments remain high as a share of household disposable income but have stabilised in recent months (Graph 1.16). The rise in interest payments over the past couple of years has contributed to weaker consumption growth (see Chapter 2: Economic Conditions). More recently, the share of household disposable income spent on scheduled mortgage payments fell a little in the September quarter, as the effects of fixed-rate expiries were offset by growth in disposable income associated with Stage 3 tax cuts. While debt payments are high, nearly all borrowers are expected to be able to service their debts even if inflation and interest rates remain high for an extended period.^[1] Payments into mortgage offset and redraw accounts picked up in the September quarter and have been around the longer term average over the past year.

While net savers benefit from higher interest rates on savings, higher interest rates on debt have caused household net interest income to fall over the tightening phase. This is because households hold more interest-sensitive debt than assets overall, despite a steady increase in interest-bearing deposits over recent years. Net household interest income remained steady in the June quarter at around –2.5 per cent as a percentage of household disposable income, a little lower than immediately prior to the pandemic (Graph 1.17).^[2]

Housing credit growth has been picking up since mid-2023 to around its post-GFC average, despite higher interest rates. The pick-up in housing credit growth has been accompanied by strong growth in housing prices and supported by the ability of households to service new debt given growth in nominal household incomes (see Box A: The Pick-up in Housing and Business Credit Growth). In liaison, banks have commented that they have been surprised by the resilience of demand in the mortgage market over the tightening phase.

Investor credit growth has increased notably this year, although the level of credit growth remains below that of owner-occupiers (Graph 1.18). Investor credit growth appears to have been supported by expectations of future capital gains; survey measures of housing price growth expectations have remained high this year. Historically, investor loan commitments have grown more strongly than owner-occupier commitments at times of rising housing prices. On average, investors also have higher incomes than owner-occupiers. Along with low rental vacancy rates and strong growth of rents, this may be supporting investors’ willingness and ability to borrow in the current environment of high interest rates and other pressures on disposable incomes.

Growth in new mortgage lending is increasingly divergent across states. This is consistent with trends in price and activity data, and partly reflects differing economic fundamentals and affordability across states (see Chapter 2: Economic Conditions).

Growth in business debt remains above its post-GFC average.

The cost for businesses to take out loans or issue corporate bonds has increased substantially since the start of the policy tightening phase in 2022 (Graph 1.19). Even so, corporate bond yields have risen by less than risk-free rates over the tightening phase as strong investor demand for wholesale debt has contributed to a narrowing in credit spreads. The higher level of interest rates has contributed to a decline in the median interest coverage ratio of listed companies over the tightening phase, but only to slightly below its post-GFC average. This partly reflects the relatively low leverage of many listed companies. The use of fixed-rate debt and interest rate hedges has also slowed the pass-through of cash rate increases to larger businesses’ effective interest rates.^[3]

Business debt growth remains above its post-GFC average and internal funding remains resilient (Graph 1.20). While the growth of business debt remains elevated, the level of business debt has been relatively stable as a share of nominal GDP. The growth of business debt is only weakly related to business investment. In part, this reflects the fact that internal funding (which flows directly from companies’ operating cash flows) makes up the bulk of funding for businesses. While internal funding for listed companies moderated in 2023/24, mostly driven by the resources sector, it remains high in nominal terms and has been broadly stable as a share of nominal GDP. For further discussion, see Box A: The Pick-up in Housing and Business Credit Growth.

Endnotes

See RBA (2024), ‘Chapter 2: Resilience of Australian Households and Businesses’, Financial Stability Review, September. [1]

While the change in net interest payments over the tightening phase has been modest, higher interest rates also work in other ways to constrain spending by a wide range of households. See Kent C (2023), ‘Channels of Transmission’, Address to Bloomberg, Sydney, 11 October. [2]

See RBA, n 1. [3]