Is the RBA losing control? Bartholomeusz

The Reserve Bank recognised some time ago that since the financial crisis monetary policy isn’t quite what it used to be. The RBA’s decision to leave official rates unchanged at this month’s board meeting may reflect its confusion about how to operate within the new environment.

The big change to the workings of monetary policy occurred during the crisis, when a spike in bank funding costs, particularly for wholesale term funding, caused banks to make out-of-cycle rate rises. Previously movements in mortgage rates had coincided more or less exactly with official rate movements, giving the RBA direct influence over lending rates.

Approaching this month’s meeting the RBA staff would have know the cases for and against a 25 basis point increase were, as the minutes released today acknowledged, “finely balanced” and, indeed, as they also acknowledged, that the next rate rise was only a matter of time. There are hints in the minutes that the RBA staff may have actually recommended an increase.

The dilemma for the central bank, however, was that the major banks had been making it known, publicly and privately, that they would add 15 or 20 basis points to any rise in official rates to recover the losses of net interest margin as their average funding costs continue to rise.

There are unconfirmed rumours circulating in banking circles that the RBA actually contacted the major banks seeking assurances that they would only pass on the RBA increase, if there were one, and not do anything beyond that. Supposedly the banks declined to provide them.

Whether or not that was the case, the RBA would have been aware of the potential for a 25 basis point increase in official rates to end up being a 40 or 45 basis point increase in actual ending rates, which might be a little too much too soon for the economy to bear.

Within the minutes there were a couple of interesting references to bank interest spreads.

“Members noted staff estimates that banks’ funding costs had been relatively flat over recent months. While the spread between lending rates and funding costs was below its peak in 2009, it remained well above its pre-crisis levels,” the minutes said.

That is quite a pointed piece of commentary, effectively saying (albeit far more politely) that the banks have no justification for making out-of-cycle hikes or moving beyond the level of an official rate rise because, while they might have fallen since last year, they are still usurious when compared with their pre-crisis levels when they were constrained by far greater competition from the regional banks and the non-banks.

The RBA has been more assertive in trying to make that case in recent months, which increases the political sensitivity for the majors of any out-of-cycle move.

The majors are itching to lift rates and their margins. They held off this month but there is an expectation that, while they’ll wait for the November meeting in the hope that the RBA will lift rates and provide cover for their own increases, they are going to move regardless of what the RBA does. To use ANZ’s Mike Smith’s language today, there is a very strong sense among the majors that “something has to give.”

The de-linking of market and official rates creates some delicate issues for the RBA, which essentially has to try to second guess what the majors will do in deciding what to do with official rates.

If it continued to sit on its hands because it was concerned the banks would add a margin to any movement in official rates, it would effectively be conceding its control of monetary policy to them. Yet, if it moves and the banks add a margin, it faces the same result.

That doesn’t mean that the banks can move with impunity. The RBA may not be able to do anything unpleasant to them but Wayne Swan made threatening noises in the lead up to this month’s RBA board meeting and will inevitably do so again.

Having seen what the Labor government did to Telstra, the majors would be taking a very real risk of triggering retaliation if they ignore the signals from the RBA and refuse to return to moving in tandem with their central bank.

This article first appeared on Business Spectator.