Transcript of Question & Answer Session Exchange Rates and Inflationary Pressures

Thank you very much, Chris. Why don’t we have a seat? Very interesting thoughts. Just housekeeping quickly. There are roving mikes around the room and so, to the extent you’ve got a question, just raise your hand and I’ll do my best to navigate the order. I might just start though. And we’ll come to inflation and FX in a minute but just start with the bond market. With the RBA and other central banks being such a large buyer of bonds through the pandemic that can have the ability to be quite distortionary to the market with respect to liquidity. What would be your observations with respect to the Australian bond market and maybe the ability to release more bonds back into the market to improve liquidity? And then I fully appreciate that the RBA review is still ongoing as well.

Sure. Let me just start by noting that the Board currently has no plans to sell bonds from our stock. There are various reasons for that but, among others, I think the cash rate can do the job it needs to, in terms of tightening conditions, monetary conditions. I think selling would complicate the task of issuance, not just by the AOFM but by the semis as well. I think, in terms of the liquidity effects, we’ve conducted a review internally of the bond purchase program ourselves, so that’s quite detailed, that’s out and published. That found no material effect, that’s not to say there was no effect, but no material effect on the functioning of those markets. I think one of the reasons is that we have a stock-lending facility. So we recognise if we’re holding a lot of stock and we just sit on that entirely and don’t release it at all, that could be problematic for market functioning. But recognising that, we do lend those bonds out when they’re needed. So I think there was a lot of demand for that around the time of the end of the yield target late last year. That’s eased back a bit, but it’s still out there, we’re lending about five billion outstanding per day, something of that order of magnitude. So, look, liquidity is tight, but you sort of expect that. That’s not just an Australian phenomenon, that’s a global phenomenon. Given the uncertainties, the large moves in yields, markets are trying to find a new home, a new place for those yields and moving a lot with news. But the market overall is functioning okay.

Excellent. Thank you. You mentioned monetary policy can probably do the trick. What’s your view just on the ability for Australian households, mortgage owners, and their ability to cope with the rapid increase of interest rates, the base rate and mortgage rates, in particular, given they’ve already gone through, essentially, the way we assess the buffer, when we’re lending out to the household?

I think the effect is going to vary across the households with mortgages, and we’re talking about household with mortgages, right? So we published some details in the Financial Stability Review recently. My assessment of that was most households will manage. But, of course, all of their budgets are under pressure from rising rates and high rates of inflation. Many borrowers, of course, are well ahead of the scheduled payments. That’s a feature of Australia, but that was amped up during the pandemic, when saving rates went very high, including by those with mortgages, so they’re well placed to make an adjustment. Some with small or no buffers, they’re going to struggle more than others. They’re likely though, our assessment is, at this stage to be a small share of borrowers. APRA’s buffers were helpful, of course—we talked about those—but, remember, many borrowers didn’t take out the maximum loans that those buffers implied, right? So that’s helpful as well. But, look, we’re going to be monitoring the effects of increased rates on household spending and, remember, we do actually want it to have an effect on household spending to rein that in somewhat.

Yeah, and I think you’ll hear from our CEO a little bit later on, and I think his view would be largely similar to yours as well, certainly to the extent you have questions for him later on. I’ll just see if there are any questions around the room before I go on. There’s one in the back corner here.

Hello. Thank you for your presentation, Christopher. My name is Adam Lang. It turns out the mining boom was kind of handy with investment in capacity. Where would you like to see the next investment in capacity come into?

It’s a good question and I understand why you’re asking it, but I always feel like an economist should stay well away from picking any winners, because that’s the first thing they would tell you. Picking winners is not the right thing. Look, we need a broad mix of investment under the right sort of conditions, including a bit less uncertainty would sort of help, but that’s a global phenomenon at the moment. Surprisingly, our liaison suggests there is not going to be a very large increase in mining investment capacity this time around. Even though the terms of trade are at an even higher peak, remember a lot of that capacity last time was put into things like natural gas and coal. And, given the need to respond to global warming, there’s going to be a lot less of that. Companies have worked that out, so they’re not undertaking that sort of investment. But it’s not for me to sort of pick particular winners or favourites. I think the market can take care of itself because we need good investment in infrastructure. There’s a lot of that going on, that’s public infrastructure and that should always be the case: that we need continual investment in public infrastructure, including while the population is growing, which will probably start to pick up again in the period ahead.

Another question?

Thank you for the speech. Peter Hannam from The Guardian. I just wondered if the trade weighted index implies only modest effects for inflation, what would a debt weighted index, in terms of Australian exposure to US borrowings, imply if the US dollar is falling? Any sort of, I guess, corporate stressors you can see coming if it suddenly gets a lot more expensive to repay in US dollars if they’re not hedged? And, just secondly, this broader issue, you did touch on global warming just then. We do seem to be in kind of endless flood zones up and down the east coast and maybe for a few more months. At what point do you think the productive capacity of Australia, particularly on the farming front but maybe in mining and elsewhere, maybe with energy production, when will that need to be adjusted to take into account what’s becoming the new reality? Thanks.

I think, on the question of debt, I hadn’t thought to put a sort of debt based TWI. It probably would … your sort of inclination would be you’d think, ’Well, we raise a lot more debt in the US, Europe, the UK, denominated in those currencies,’ so you might sort of think, ’Well, it might be quite different.’ But I think you have to acknowledge that the vast bulk of it is hedged one way or the other, either through financial instruments, that’s what the banks use when they’re doing swaps, or natural hedges, so the resource companies that are actually selling commodities that are denominated in foreign currencies. So, I don’t think it would really make a big difference and, actually, when the Aussie dollar depreciates, that can sometimes, as you suggest, make you think, ’Oh, it’s going to be harder to pay those US dollars back’ but no, because they’re fully hedged and, actually, there’s a flow in an accounting sense that the banks are receiving on margin payments when the dollar depreciates. In terms of the global warming, look, I think it’s hard to make aggregate statements about sort of capacity and what that should do and how it should change. I mean, Australia’s gone through very long cycles of drought, fire, flood. So it’s obviously incredibly painful for the farmers that are facing flood after flood in recent times down the eastern seaboard, but I’m not sure I can sort of opine too much on sort of the longer term, broader aggregate effects of that.

Just down the front here, yes. Let me come down to this gentleman and then I’ll come back up to that table.

Thank you for your comments. You touched on how kind of separating the interest rate decision from sort of the asset purchase decision you think, rates can meet a lot of goals that the RBA has right now on the policy side. You’re hearing other central banks around the world, I think the Bank of England is maybe the most extreme case of separating that interest rate and balance sheet, asset/purchase balance sheet decision in a way that’s almost counterintuitive. In the past, we’ve seen cut rates to zero and use our supports just to reinforce that message so markets will price in lower rates for longer. Now we’re getting rate increases but also sort of targeted asset purchases. We’re seeing, the Bank of England just announced they’re going to be reducing their balance sheet but to do it for bonds less than 20-years in maturity, knowing those long-maturity bonds are the problems for their pension funds. The European Central Bank is talking about, you know, raising rates but a purchase facility to buy Italian bonds, in case things go bad in Italy. Is this credible policy to have the balance-sheet policy go against what the interest-rate policy is doing or is this the feature of central banking, where the balance sheet can now be used for financial stability purposes and not for rate-setting purposes?

I think the starting point there is, first and foremost, financial stability is absolutely critical because, without it, you can’t achieve your monetary policy goals. And stop worrying about transmission, if your market’s truly dysfunctional and financial stability is at risk. So that’s always the sort of high priority in the near term. And you can understand that’s why the Bank of England came in and conducted the purchases they did in a very targeted part of the market that was most problematic. Obviously, that sits a bit uncomfortably with the need to address high inflation through tighter monetary policy conditions. But, I think what they’ve conveyed and what they’ve done so far has been very focused, very short-term, so now they can get back on with the business, assuming that markets can be more stable now—let’s keep our fingers crossed, so far so good—but they can get on with the business of tightening financial conditions. So maybe that tension is going to be there. But it’s no good sort of worrying about the need to sort of tighten monetary policy and completely ignore those really acute episodes of dysfunction that might happen from time to time, as did in the UK gilt market over the last few weeks.

Thank you.

We’ll just come back up to this corner.

Hi. Thanks for fielding my question. My name is Carl and I’m from Ausbiz. I just had a question on credibility. Obviously, there’s the discussion about the RBA’s credibility with households, and there’s been a very transparent review into what went wrong in terms of communication. But my question applies a little bit more to credibility in the marketplace. Obviously, there were the issues with yield curve control when that broke down and also perhaps the RBA being caught off or, sorry, market participants being caught off guard perhaps by the size and rapidity of the RBA’s hiking cycle, that perhaps there was a miscommunication and also an issue with signalling there to market participants. I want to know if there was any sense that perhaps there might be a greater risk premium being baked into Australian government bonds, on the basis that the RBA has lost a level of credibility in the short term, also whether that has an impact on the exchange rate in any sort of non-trivial way? And also, perhaps as a secondary to that, whether the … what’s been priced into rates markets—well, this is sort of a second part of the question—but what’s been priced into the rates markets at the moment is a cash rate mixture of somewhere around four per cent, seemingly following expectations of tighter Fed rate policy. Does that kind of follow the leader dynamic, have any credence, in terms of the way that you consider policy, or is that just markets overshooting? Thanks.

Sorry, I’m just not quite sure of that last part?

Pardon me. I just notice that, in terms of Cash Rate Futures markets, we’ve seen a fairly significant shift in terms of the expectations for the terminal rate mostly, it would seem, based on expectations that the Fed Funds Rate could climb above five per cent, so not so much based on Australian fundamentals but, obviously, the exchange-rate impacts that that might have as well as just high global rates. I just want to see if there’s any credence into what markets might be pricing in, or is it just markets doing funny things?

Yeah, sure. I’ll do my best to answer that. There’s quite a bit in there. I mean, the starting point is, yes, we acknowledge things like the way the yield target ended was costly in terms of the Bank’s credibility. The bond purchase program ended a lot more smoothly and we’ve learnt some lessons from that, comparing and contrasting the two. We’re currently conducting an internal review of forward guidance and we’ll be publishing that later this year, so that will touch on some of these elements. But, just stepping back and thinking about sort of monetary policy over the course of this year, since we started raising rates in May—and we haven’t been alone in raising rates rapidly. We’re a bit different in some ways, and you need to be a bit cautious and careful to sort of compare rate increases at any given meeting because we meet more frequently and the Deputy Governor, Michele Bullock, made that very clear in her speech recently. But I think the markets have attended broadly to the notion that, yes, inflation is high here, it’s not quite as high as elsewhere. But, in particular, wages growth had picked up from very low levels, which is why I wanted to emphasise where we’d come from in my speech. They’re picking up now from those very low levels, and that’s something that we were actually looking for. But they’re very different from—at this stage- from many advanced economies, including the US, which you flagged, which has got wages growth which is not consistent with their inflation target, it’s too high and it needs to come down in nominal terms. I think markets have attended to those sort of differences across economies and so our path for the cash rate is not as high as for some other economies, including the US, as you flagged. And, as I showed in my last chart there, that interest rate differential, that’s why the interest rate differential has come down, the Aussie has depreciated a bit. But I think that’s all okay, the Aussie dollar is doing what it needs to do. So I think the broad picture is well understood by markets, those differentials across economies, their situations, and the Aussie dollar is just reflecting and responding to those.

Yeah. And, look, you’re one of the first central banks to slow the rate of tightening. At what point though does that interest rate differential become a problem for the Aussie dollar? I thought you were very articulate in the way the TWI makes a difference for Australia versus just the outright US-dollar rate. But how much do you take that into consideration and when could it be a problem, if you really do think there’s a big difference between, the makeup of wage inflation in Australia versus the US, for example?

I don’t see it as likely to be a problem. I see that interest rate differential and the response of the exchange rate is just a natural response to differences in the economy’s fundamentals. And, as I suggested, the Australian exchange rate, the TWI, which is the one that sort of matters for inflation that has depreciated but by a lot less than against the US dollar. And the level of the TWI and its moves, broadly speaking … and there’s a lot of uncertainty around these models … but they’re broadly in line with our fundamental determinants. Commodity prices are still elevated, right, which is also one thing that sets us differently from many other economies which are experiencing big terms of trade shocks, like in Europe, that are adverse, but the interest rate differential as well. So the TWI is sort of doing more or less what you might expect it to do, and I wouldn’t think that that’s a significant concern.

Okay. Are there any other questions from the floor? The back corner?

Good morning, Chris. Laurence Davison. I want to ask if the RBA has started to think differently about lagging effects. There was some research earlier this year from CBA, suggesting that it might take two to three months for a rate increase to feed through to the household, even in a variable rate mortgage. And you mentioned, obviously this is a fairly unprecedented rapidity of hikes, and we’re only just starting to see at the margin things like household-spending intentions coming off. I guess that a sort of question within the question is whether that increases the risk of overshoot.

Well, I think you’re right to highlight the importance of the fact that monetary policy operates with a lag, and I think that is the challenge that faces not just us but other central banks when you’re raising rates rapidly. That’s why I thought it was an important way to sort of just convey, in that first chart, just how rapid this is. Last time we saw a move of this much globally, four years it took; four quarters this time around. So it operates with a lag, and I think that means that the tightening, as you said and as CBA has flagged and others, the tightening is still working its way through. The tightening up until the last rate increase at the last Board. That’s still going to take some months before it affects mortgage payments, those are the natural lags. We do have a large share of variable-rate mortgages, much larger than most other advanced economies, so those effects come through fairly quickly. The other thing is, we had a lot of fixed-rate mortgages undertaken during the pandemic, partly in response to those low fixed-rate loans that were a response, in turn, to our policy measures. But a lot of those were fairly short term and they’re starting to increasingly roll off over the period ahead. So you do need to think very carefully about lags, and you do need to think about monetary policy and try and look forward when setting it.

Down here in the front, just down here. Thanks.

Good morning. Philip Brown from the CBA. Also a question on lags, in a sense. I was wondering, if the pandemic hadn’t happened, do you think we’d finished the shadow of the mining boom, because we went into the pandemic with a much weaker economy and a much lower cash rate than most of the rest of the world and, on your chart, you had the TWI falling back to a 100 but, before the mining boom, it had spent most of those years noticeably below 100. And I ask that because how much of the stimulus applied during the pandemic actually was effectively used to mitigate that mining boom shadow, and how much of it is actually stimulus that we’re now seeking to unwind?

I think that’s a hard to know with any certainty. But my rough sense is that the real exchange rate, it wasn’t doing a lot. It moved lower partly in response to our cuts to interest rates in 2019, and they were really designed to stimulate the economy and generate higher nominal wage growth and help bring inflation up more broadly. It’s very hard to speculate what might have been and what could have happened. But my sense was that enough time had passed since that peak in mining investment for its effects and aftershocks to sort of have completely worked through the system. But the surprising thing is that wasn’t a process that just took one or two years, I think it took a few more years. Would it have needed even more time, more than seven years? Probably not. I really don’t think so.

Thanks, Chris, for your speech. On the wages side of things, you obviously highlighted the big adjustments that had occurred previously. Now, in this recent period, Australia has a wage growth figure that appears a bit out of kilter with … particularly with the US but a number of other places, I guess what I’m wondering is why. Do you think there are institutional or structural factors in Australia that are keeping wages at a lower level than elsewhere and, therefore, it sort of makes your task a bit easier than other central banks, or is it another lag and what we’ve seen in the United States and elsewhere, a risk of occurring here?

I think there must be, and there are some institutional factors, right? A large share of wage setting is done under longer term arrangements, whether there’s an agreement that takes place over two to three years, so that just imparts some inertia. So, having started very low and starting to move up, that process tends to be a bit slower because of that. Of course, that can work the other way and make the task more difficult, if wage growth gets too high. Let’s hope that’s not on the cards. It doesn’t appear likely—that’s certainly not in our forecasts—and, in particular, because we actually started raising rates at about the time we could see indications that wage growth was lifting off where it had been. So that was a good thing. But it certainly hadn’t got out of control, by any means, certainly not where wages growth was in many other countries that have a much more significant problem with wages growth in terms of nominal wage growth well above their inflation targets. So we started before that became an issue. Some criticised us, we started too early, we didn’t see convincing evidence from the ABS. But we were seeing it in liaison, we were seeing it everywhere that wages growth was picking up, and that’s what’s come to pass.

Hi there, Jonathan Shapiro from Australian Financial Review. I have two brief but unrelated questions. The first is on the term funding facility. There’s about $200 billion of funding rolling off in the next 18 months. My question is on the Reserve Bank and what modelling or forecasting or assumptions you’ve made about what that might do to bank funding costs. And the second question is that we’ve had, the large prices boom that we’ve experienced in the mining sector over recent years. I’m wondering if you think that may have skewed profit and productivity data over the past decade. Thanks.

Maybe I’ll take that second one first. I mean, it did have a big effect on measures of productivity and was part of the reason why unit labour costs were doing what I suggested. When we were all spending a lot of time and effort putting that infrastructure in place across the economy, leading up to the peak in the mining investment boom, that investment hadn’t yet been turned on. It wasn’t producing anything, so aggregate measures of productivity were growing much more slowly then. Then, as the infrastructure is turned on, suddenly there’s a lot of productivity and you’re actually using less workers in that sector. So those sorts of big moves did have an effect on the aggregates. I’m not sure that that’s sort of an enduring effect now. On the TFF: yeah, it’s 188 billion outstanding, that’s roughly what’s due, a good tranche of it by September of next year and then the rest by June of the following year. Remember though the banks, when they were taking it out, took it out over a period of time. They didn’t come in on the last day it was available and take it all in one hit, so they naturally spread some of their take-up of that. And the very strong expectation, what we hear directly from banks, what APRA are talking to the banks about, is to manage this process carefully, recognising you can’t raise all of the money that you need to replace that funding in one go, at the last minute, all together… you’ve got to spread it over a period of time. So I think there’s every reason to expect that they’ll do that. In terms of the cost, well, we don’t know quite what markets are going to be doing at that time, it’s still a long way out. But, remember, it accounted for something in the order of about four, five per cent of credit, so it’s not a really large share of their funding. Most of the Bank’s funding costs, in any case, are determined by the short end of the curve, three-, six-month BBSW.

Thanks, Chris, Aaron Jackson Westpac Treasury. I know one thing the RBA has referenced before is the spread between the government bond curve and the OIS curve. Obviously, that’s deeply negative now, with distortions at particular points. The April 24 is sort of 60 under OIS or something at the moment; we’ve got, no term premium in the bond market, the ASX has recently had to take actions to increase liquidity in the futures market. Are these sort of things that you’re concerned with at the moment, or how are you sort of thinking about them?

Not particularly. As I said at the outset to Andrew, I think our overall assessment is liquidity globally in bond markets is a bit less than it had been to varying degrees across economies. That’s natural in a time of considerable uncertainty about the macro outlook, but I don’t think it’s having a sort of materially adverse effect on how our market is functioning. I think our market is functioning well enough, all things considered. Some of the things you point to, I mean, some of those yields on some securities at the shorter end of the curve being a bit lower than OIS that may just be because there are certain buyers that have mandates to only hold those sorts of instruments for liquidity purposes. They’re in high demand, relatively short supply, partly because we bought quite a few of them, but we’re lending our stock out to help trading in those markets. So I think they’re functioning well enough to not be of a significant concern.

We’ve got time for one more question, if there is one. There we go, the back right corner.

Thank you. Assistant Governor, a lot of economists and financial commentators reckon major economies, like the US, the UK, Europe, are heading towards recession, and China’s economy isn’t doing too great either, there’s a massive slowdown happening there. So, in that context, how worried are you that Australia’s economy might not achieve a soft landing, given the path is already quite a narrow one?

You almost answered the question for me. But, I mean, you’re right. Europe is in a very difficult position, they’ve been very hard hit by not just energy prices but also the availability of that energy, and they’re facing potential rationing. The US had very rapid interest rate increases dealing with very high inflation and very high nominal wage growth. China, yes, zero-COVID, that’s a significant headwind, but their property market is facing very significant headwinds as well, and we’ve talked about those in the past. It’s worth remembering though and I had a sense of this in my speech that slower demand overseas, that helps bring global inflationary pressures down and those are not the only reason for our high inflation, but they’re an important part of it. So that’s a helpful aspect. What about us? Well, we’re not so affected by energy in quite the same way. And, for much of our economy, of course, it represents a positive thing because we produce a lot of energy and export it. So it’s a positive in terms of trade shock. In Europe, it’s a negative. We’ve got lower wages growth, but the labour market is very tight and we need to address the implications of that. Growth is still strong. Could it slow? Will it slow? Probably. That’s partly what monetary policy is seeking to achieve, and it is having its effect. But, as you say, we don’t expect a recession. There’s lots of uncertainties, there always are but especially now and inflation needs to come down. So it’s a very narrow path, as you’ve described.

Just to clarify, the other economies, like the US, the UK, Europe are probably heading into a recession, but we’ll be okay; they’re going into a recession but not us. Is that your forecast?

Oh, no, those are your words. I think I handed you the best …

That’s how I’m interpreting.

Yeah, no. Those are your words. I think, ’it’s a’—’it’s a narrow path’ is a useful description.

All right.

Thank you.

Well, Chris, thank you very much for coming along today. We greatly appreciate your insights but also your honesty and transparency in the way you answered the questions. We’re in your hands collectively. We wish you all the best, navigating a complicated set of circumstances. Please join me in thanking Chris Kent.

Thank you. Thanks all.