Statement on Monetary Policy – February 20251. Financial Conditions

1.1 Interest rate markets

Most advanced economy central banks reduced their policy rates further in recent months.

Having lowered their policy rates materially from peak levels, some advanced economy central banks are signalling that further reductions may be more gradual or dependent on favourable data. Many have highlighted US trade policy as a significant source of uncertainty to the economic outlook (see Box A: Implications of US Policy Settings for Financial Markets).

The Fed kept its policy rate on hold at its January meeting and said that it will be looking for confirmation of further progress on inflation or signs of a weakening labour market before considering further adjustments, while noting that its current policy rate remains restrictive. The Bank of Canada (BoC) has also signalled a more gradual approach following its most recent rate cut and stressed the difficulty of assessing the appropriate future path of monetary policy, given uncertainty about potential tariffs. Meanwhile, the Reserve Bank of New Zealand cut its policy rate by a further 50 basis points and signalled it expects to do so again in February. The European Central Bank has also reduced rates in the face of ongoing slow recovery in growth. The Bank of Japan increased its policy rate in January in response to upside inflation risks.

The BoC announced the end of its passive quantitative tightening program as it nears its estimate of the level of reserves required to meet underlying demand. Other central banks that pursued asset purchase programs during the COVID-19 pandemic have indicated they intend to continue reducing the size of their asset holdings.

Market participants’ policy rate expectations now point to fewer rate cuts in the United States compared with the November Statement but are little changed in most other advanced economies (Graph 1.1). The increase in the United States reflects generally strong data on the labour market and economic activity more broadly, as well as the potential inflationary impacts of the new administration’s trade, fiscal and immigration policies. In other economies, economic data has generally not been as strong as in the United States, and there is concern about the negative growth implications of potentially higher tariffs.

In Australia, market participants have brought forward their expectations for cuts to the cash rate.

Market participants are pricing a very high likelihood that the Reserve Bank Board will cut the cash rate target by 25 basis points at the February meeting. The expected path for the cash rate has shifted down since the November Statement, with roughly three rate cuts priced in for 2025 and another one early next year (Graph 1.2). While the cash rate is anticipated to decline faster than it was in November, expectations for the cash rate at the end of 2026 are little changed. This followed the December policy decision, and associated communication; the expected path declined further following lower-than-expected GDP and inflation data. A reduction of 25 basis points in February is expected by almost all market economists we track.

Long-term government bond yields have increased in the United States but are little changed in Australia since the November Statement.

The increase in government bond yields in the United States reflects expectations for fewer cuts to the policy rate and uncertainty around US trade, fiscal and immigration policies and their potential impact on inflation and growth (Graph 1.3). Real yields have risen moderately, and the US yield curve has steepened (Graph 1.4). This also reflects an increase in measures of term premia, albeit to still low levels by historical standards. Measures of short-term market-based inflation compensation have also risen over this period (see Box A: Implications of US Policy Settings for Financial Markets).

Long-term bond yields have also increased in Japan as market expectations for future policy tightening have risen. In most other advanced economies – including Canada, Germany, New Zealand and the United Kingdom – yields have risen by less than the in the United States or are little changed, in part reflecting fewer upside surprises to economic activity data and a perception that those economies are more vulnerable to downside risks to growth from potential US tariffs.

In comparison, yields on Australian Government Securities (AGS) are little changed since the November Statement, and have moved below US Treasury yields for the first time since mid-2024. This is consistent with the relative change in expectations for policy rates in Australia and the United States. Long-term AGS yields have moved below US Treasury yields for the first time since mid-2024.

The cash rate is currently above central estimates of the neutral rate.

The cash rate is above the RBA’s and market economists’ central estimates of neutral (Graph 1.5). However, there is a large degree of uncertainty about these estimates. There is a wide range of model estimates, and each individual estimate is subject to its own uncertainty. Accordingly, the neutral rate is difficult to identify and incoming data and refinements to models can lead to significant revisions. The RBA has recently refined how the models account for the pandemic period, following the techniques of other central banks. This has led to a shift downward in some estimates of neutral and is consistent with our assessment, based on a broader range of indicators, that financial conditions remain restrictive and the observation that private demand has been weak for some time.

1.2 Other measures of financial conditions

Several measures of private sector financial conditions have eased further in advanced economies, with the pricing on some riskier assets reaching new highs.

Equity prices in most advanced economies, including Australia, have risen since the November Statement (Graph 1.6). US equity prices have increased on strong economic data and expectations that the positive impact of corporate tax reform, deregulation and fiscal stimulus will outweigh the negative effects from more restrictive trade and immigration policies. In the United Kingdom, euro area and Japan, equity prices have risen despite tariff concerns and broader geopolitical risks. This is partly because the depreciation of local currencies has contributed to an improvement in the local currency earnings outlook for export-focused companies and the offshore operations of multinationals, which constitute a large proportion of these indices (see Box A: Implications of US Policy Settings for Financial Markets). In Australia, broad-based gains have offset tariff-related declines in the materials sector.

The equity risk premium remains around its lowest levels since 2009 in Australia, is at its lowest level since 2002 in the United States and near recent lows for most other advanced economies (Graph 1.7). These low-risk premia have been sustained despite the escalation of trade tensions. This suggests that markets consider the likelihood of scenarios that lead to material decline in economic activity and earnings to be low. However, equity prices could fall sharply in response to developments that challenge these assumptions.

Spreads on corporate bonds in the United States and euro area have narrowed a little further since early November, particularly on sub-investment grade debt (Graph 1.8). Consistent with the low pricing of risk in equity markets, spreads on corporate bonds in the United States and euro area are near 15-year lows. This reflects market expectations of a relatively benign credit cycle, as well as an elevated appetite for risk and strong investor demand. As a result, corporate bond yields in the United States and euro area have generally declined or increased only modestly despite the increase in risk-free rates. Yields on corporate bonds in Australia are little changed.

Credit growth has picked up in many economies and remains relatively strong in Australia.

Growth in total external funding of non-financial corporations (NFC) has increased since the start of 2024 in the United States and euro area, due to strong corporate bond issuance and increased credit growth (Graph 1.9). Equity issuance has also picked up in the United States, consistent with positive investor risk sentiment. Growth in external funding has been a little stronger in Australia relative to GDP, in part reflecting robust investor demand for non-financial corporations’ bonds and strong lending competition among banks.

Credit growth for households has also increased over 2024 in the euro area but has remained steady in the United States over this period. Lending surveys suggest that banks are generally no longer tightening lending standards for households or firms, and in some cases are starting to ease lending standards in the United States and euro area. In Australia, the RBA’s liaison program suggests that lending conditions have been little changed in recent quarters.

Although the Chinese authorities have signalled additional monetary policy easing, asset prices continue to reflect a challenging domestic and external economic environment.

Since the November Statement, the Chinese renminbi has depreciated by 2.7 per cent against the US dollar amid broader US dollar strength, higher US tariffs on Chinese exports and an uncertain outlook for the Chinese economy. That said, the renminbi has been broadly unchanged on a trade-weighted basis. Authorities have actively leaned against the pace of depreciation and continue to emphasise the importance of currency stability, which may be a constraint on further monetary policy easing.

The People’s Bank of China (PBC) has committed to easing monetary policy further to help achieve the authorities’ growth objectives amid concerns about ongoing headwinds to growth (such as the weakness in the property sector) and the impact of the US administration’s trade and technology measures on China (see Chapter 2: Economic Conditions). Longer term Chinese Government bond (CGB) yields have declined to around historical lows amid strong demand for bonds and persistently low inflation (Graph 1.10). Household credit growth has increased in recent months alongside some signs of stabilisation in the property sector but remains at a low level.

The US dollar has appreciated against most major market currencies over recent months.

The US dollar trade-weighted index has appreciated by 3 per cent since the November Statement, reaching multi-decade highs (Graph 1.11). Several factors have supported US dollar strength over the long term, including strong relative productivity gains and economic growth more broadly relative to other economies (which is reflected in higher US yield differentials), and improvements in the US terms of trade. More recently, market participants have pushed back their expectations for further US monetary policy easing. The US dollar has also been supported by expectations that the currencies of countries targeted by US tariffs may depreciate further to offset their impacts and the potential for global trade tensions to escalate further (see Box A: Implications of US Policy Settings for Financial Markets).

The Australian dollar has depreciated alongside broad-based US dollar strength.

The Australian dollar has depreciated by 5 per cent against the US dollar since the November Statement and by 2 per cent on a trade-weighted basis (Graph 1.12). This has largely reflected broad-based US dollar strength over this period. In addition, the yield differential between Australian and both US and Japanese government bonds has declined.

The Australian dollar trade-weighted index (TWI) is now at the bottom of the range observed since 2022. This is consistent with the Australian dollar’s tendency to be more sensitive to movements in the US dollar and global growth cycle. Uncertainty around the outlook for the Chinese economy – exacerbated by the possibility of higher US tariffs on Chinese goods – has further weighed on the value of the Australian dollar against the currencies of other major trading partners. In addition, Chinese authorities have leant against the depreciation of the renminbi over recent months, contributing to the 2 per cent depreciation of the Australian dollar against the renminbi since early November; the Chinese renminbi holds a 30 per cent weight in the Australian dollar TWI.

In real terms, the Australian dollar TWI has depreciated over the March quarter to date but remains close to the model estimate implied by the long-run historical relationship with the forecast terms of trade and real yield differentials (Graph 1.13).

1.3 Australian banking and credit markets

Conditions in money markets have been stable and key rates remain consistent with the Reserve Bank Board’s policy stance.

Short-term funding markets functioned well over year-end. Rates in short-term funding markets remain within recent ranges and the cash rate has continued to trade close to the cash rate target (Graph 1.14). Exchange Settlement balances held by banks have risen modestly in recent months, in part reflecting the usual seasonal pause in bond issuance by the Australian Government over year-end (Graph 1.15). As a result, demand by banks for borrowing from the RBA’s overnight market operations (OMOs) has declined slightly.

Banks’ funding costs were little changed in the December quarter, and wholesale funding market conditions remain favourable for financial institutions.

Banks’ estimated funding costs were stable in the December quarter, reflecting no change in the cash rate and little change in short-term market rates. Bank bond spreads relative to the swap rate – a reference rate for the pricing of securities – declined over 2024 and remain close to their lowest levels since early 2022, despite a small increase since November (Graph 1.16). Bank bond issuance (both domestic and offshore) has been steady alongside ongoing strong investor demand.

Conditions in the Australian asset-backed securities (ABS) market – a key source of funding for non-bank lenders – continue to be favourable for issuers. Issuance of ABS has been strong, supported by elevated investor demand, with 2024 recording the highest level of issuance relative to GDP since the global financial crisis (GFC). Spreads remain narrow across asset-backed markets, particularly for lower rated tranches of securities.

Financial conditions for households have been little changed since the November Statement.

Scheduled mortgage and consumer credit payments remain high as a share of household disposable income. The value of scheduled mortgage repayments as a share of household disposable income stabilised over the second half of 2024 (blue bars in Graph 1.17). While nominal repayments increased alongside higher credit growth and remaining fixed-rate expiries, this has been offset by growth in household disposable income. Variable mortgage rates have also been little changed over recent months. A few banks have reduced advertised interest rates on new fixed-rate housing loans in recent weeks alongside a slight easing in benchmark (swap) rates, but the fixed-rate share of new housing lending remains low. The rise in household interest payments since 2022 has put pressure on household budgets, which has contributed to weak consumption growth over the past few years and an increase in housing loan arrears to around their pre-pandemic levels.

Payments into mortgage offset and redraw accounts picked up over the second half of 2024 and are a little above their pre-pandemic average (Graph 1.18). The increase in excess payments over the second half of 2024 (grey bars in Graph 1.17) might reflect a higher rate of overall saving from mortgagors over this period, though other factors can also influence the aggregate flow of excess payments (e.g. funds transferred from other sources of savings). Indeed, the overall rate of saving across all households increased slightly in the September quarter of 2024 but remained below its pre-pandemic average (see Box B: Consumption and Income Since the Pandemic).

Housing credit growth has increased further to a rate above its post-GFC average, though household credit has been declining as a share of household disposable income. Housing credit growth has increased by 2 percentage points since its mid-2023 trough, to be slightly above its post-GFC average (Graph 1.19). While owner-occupier credit growth is showing signs of moderation, investor credit growth has continued to increase. This is despite housing price growth and turnover – which typically move closely with investor lending – having trended lower in recent months. If this relationship holds, investor credit growth could slow over coming months. New lending remains divergent across states and territories (similar to trends in housing prices), driven by differing economic fundamentals, relative affordability and state policy settings. Despite the increase in housing credit growth, total gross household debt (net of offset balances) has broadly declined as a share of household disposable income since 2018 and remains in the relatively narrow range seen over the past two decades or so (Graph 1.20).

Growth in business debt has increased further and is above its post-GFC average.

Business lending rates and corporate bond yields increased substantially over the tightening phase but have been little changed recently (Graph 1.21). Credit spreads remain around their pre-pandemic levels, supported by strong demand in both domestic and offshore markets.

Business debt growth remains above its post-GFC average, driven by strong business credit growth, though measures of aggregate business leverage remain relatively low (Graph 1.22). Business debt has increased slightly as a share of nominal GDP since mid-2023. Business credit growth has been robust and picked up further in the December quarter, with banks noting that competition in the business lending market is strong. Demand for corporate bonds from wholesale investors remains robust, following strong issuance over 2024. Profitability for most businesses remains around pre-pandemic levels, which has supported businesses’ ability to borrow despite higher interest rates. Recent robustness in debt growth has been broadly based across industries, with the real estate and industrials industries contributing strongly to total business debt growth since early 2022.

The cost of equity for businesses is estimated to have declined since late 2022, partly offsetting the above-average costs of debt funding for businesses’ overall cost of capital. However, equity issuance has remained below decade-average levels, following a period of elevated economic uncertainty and high interest rates. Listed companies’ internal funding flows remain around historical average levels relative to GDP, which may limit companies’ need to raise external equity.