Philip Lowe: Remarks at Reserve Bank Board Dinner
Remarks by Mr Philip Lowe, Governor of the Reserve Bank of Australia, Reserve Bank Board
Dinner, Melbourne, 4 April 2017.
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Good evening.
On behalf of the Reserve Bank Board I would like to warmly welcome you all to this dinner.
We are very pleased that leaders from the worlds of politics, academia and the community
sector, as well as from business, have been able to join us tonight. Having leaders join us from
right across the community is important to us, as the decisions made by the Reserve Bank
Board and by the Bank affect all Australians. Price stability, financial stability, sustainable growth
and employment, and a well-functioning payments system matter to all of us. Each of these is
important to our collective prosperity. So thank you all for being here tonight.
This is the first of these dinners that I have had the honour of hosting. A particular privilege is to
be able to do so in Melbourne, where we had our Board meeting today at our offices on the
corner of Exhibition and Collins streets. Four of our nine Board members are based in
Melbourne, with Carol Schwartz recently joining Cath Tanna, Kathryn Fagg and Ian Harper on the
Reserve Bank Board. It was more than 30 years ago that we last had four residents of Melbourne
on this Board and, on that occasion, it was only for a very short period.
At our meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent. As
usual, the reasons for our decision were set out in the statement issued shortly after the
meeting.
I don't propose to run through all the issues that were considered by the Board. But there are two
issues that I would like to talk about.
The first is the improvement in the global economy. Business and consumer sentiment have
lifted in many countries and global trade and industrial production have picked up as well.
Commodity prices are also higher than they were for most of last year. Headline inflation rates
have returned to near normal levels in many countries, boosted by higher oil prices. And the point
of maximum global monetary stimulus looks to have passed. Given all this, at the G20 meetings
that the Treasurer and I attended in Baden-Baden in Germany two weeks ago, the tone was
much more positive than it had been at previous meetings. Encouragingly, over recent months
forecasts for global growth have been revised up, not down as has been the case for the past
four years.
So this is a better position than we found ourselves in this time last year.
There are, of course, still some clouds on the horizon. One that dominated discussion at the G20
meetings was a possible retreat from an open rules-based international trading system. If this
were to occur it would, clearly, be bad for Australia and the world economy. The positive aspect,
though, of these discussions is that they have generated a renewed focus in some countries,
including in most emerging market economies, on the importance of the open international
trading system. We have a lot riding on this being the outcome.
The improvement in the global environment is helping us here in Australia. Commodity prices are
up and there has been some improvement in business sentiment as well. And investment
outside the resources sector looks to be gradually lifting after being weak for many years. So this
is positive news. Labour market conditions, though, remain pretty soft. Growth in employment is
slow and wage growth is the lowest in some decades. We will want to see an improvement here
before we can be confident that growth in the overall economy is strengthening. We will also
need to assess the effects on the economy from the damage and disruption from Cyclone
Debbie in Queensland and the floods in northern New South Wales. It is still too early though for
a full assessment to be made.
The second issue that I would like to talk about is the level of household debt and the housing
market.
This is something we have been focused on for some time. The level of household debt in
Australia is high and it is rising. Over the past year the value of housing-related debt outstanding
increased by 61⁄2 per cent. This compares with growth of around 3 per cent in aggregate
household income. The result has been a further rise in the ratio of household debt to income,
from an already high level.
In aggregate, households are coping reasonably well with the higher debt levels. Arrears rates
remain low and many households have built up sizeable buffers in mortgage offset accounts. At
the same time, though, slow growth in wages is making it harder for some households to pay
down their debt. For many people, the high debt levels and low wage growth are a sobering
combination.
In the housing market, conditions continue to vary considerably across the country. The
Melbourne and Sydney markets are very strong and prices are increasing briskly. In contrast,
conditions are more subdued in most other cities and, in some areas, most notably Perth, prices
have declined. Nationally, growth in rents is the lowest for some decades.
So it's a complex picture and there is not a single story that applies across the country. But, as is
often the case in economics, it largely comes down to supply and demand. On the demand side,
population growth in Australia - especially in our largest cities - picked up unexpectedly in the
mid 2000s and it is only in the past couple of years that the rate of home building has responded.
This imbalance was compounded by insufficient investment in the transport infrastructure
needed to support our growing population. Nothing increases the supply of well-located land like
good transport links. Underinvestment in this area is one of the factors that has pushed housing
prices up. Put simply, the supply side simply did not keep pace with the stronger demand side.
The result has been higher prices.
Not surprisingly, the rising prices have encouraged people to buy residential property as an
investment in the hope of ongoing capital gains. With global interest rates so low, many investors
have found it attractive to borrow money to invest in appreciating residential property. This has
reinforced the upward pressure on prices.
This configuration of ongoing increases in indebtedness and rising housing prices has been
discussed at length by the Council of Financial Regulators. This council, which I chair, brings
together the heads of the RBA, APRA, ASIC and the Australian Treasury. The concern has not
been that these developments have posed a risk to the stability of our financial system. Our
banks are resilient and they are soundly capitalised. Instead, the concern has been that the
longer the recent trends continued, the greater the risk to the future health of the Australian
economy. Stretched balance sheets make for more volatility when things turn down.
Given this, over the past couple of years there has been a concerted effort by APRA to
encourage lenders to strengthen their lending standards. This followed deterioration in these
standards a few years ago. Also, at the end of 2014, when growth in investor lending was
accelerating, APRA announced that it would pay very close attention to lenders whose investor
loan portfolios were growing faster than 10 per cent. It did so with the full support of the RBA.
This guidance helped pull the whole system back and has made a positive contribution to overall
financial stability. So too has ASIC's focus on responsible lending. These measures constrained
some higher-risk lending and reinforced the message to lenders that they need to take a system-
wide focus in their risk assessments.
Notwithstanding this, given recent trends and the heightened risk environment, APRA announced
some further measures last Friday. Again, it did this with the full support of the Council of
Financial Regulators.
There are two parts of APRA's announcements that I would like to draw your attention to.
The first is the need for lenders to have a very strong focus on serviceability assessments.
Despite the focus on this area over recent times, too many loans are still made where the
borrower has the skinniest of income buffers after interest payments. In some cases, lenders are
assuming that people can live more frugally than in practice they can, leaving little buffer if things
go wrong. So APRA quite rightly has said that lenders can expect a strong supervisory focus on
loans with a very low net income surplus.
The second area is interest-only lending. Over the past year, close to 40 per cent of the housing
loans made in Australia have not required the scheduled repayment of even one dollar of
principal at least in the first years of the life of the loan; only interest payments are required. This
is unusual by international standards. In some countries, repayment of at least some principal is
required on all housing loans for the entire life of the loan. In other countries, interest-only loans
are available only if the borrower has already contributed a fair degree of equity. So this is one
area where Australia stands out. We are not unique in this area, but we are unusual.
There are a couple of factors that help explain the popularity of interest-only loans in Australia.
One is the flexible nature of Australian mortgages. Many people with interest-only loans make
significant payments into offset accounts rather than explicitly paying down principal. This
flexibility, which is of value to many people, isn't available in most countries. A second factor is
the taxation arrangements that apply to investment in residential property in Australia.
Last week APRA stated that it expected that new interest-only loans should account for no more
than 30 per cent of the flow of new loans. It also stated that institutions should place strict limits
on interest-only loans with high loan-to-valuation ratios.
Like the earlier 'speed limits' on investor lending, these new requirements should help the whole
system pull back to a more sustainable position. A reduced reliance on interest-only loans in
Australia would be a positive development and would help improve our resilience. With interest
rates so low, now is a good time for us to move in this direction. Hopefully, the changes might
encourage a few more people to think about the merit of taking out very large interest-only loans
when interest rates are near historical lows.
So the RBA welcomes these latest changes.
It is important, though, that we are all realistic about what these and other prudential measures
can achieve. As I said before, the underlying driver in our housing market is the balance between
supply and demand. The availability of credit is undoubtedly a factor that can amplify demand, but
it is not the root cause. This assessment is consistent with the observation that housing market
dynamics currently differ significantly across the country, despite Australia having nationwide
financial institutions and the level of interest rates being the same across the country. It is hard to
escape the conclusion that we need to address the supply side if we are to avoid ever-rising
housing costs relative to our incomes and to avoid the attendant incentive to borrow that is
created by rising housing prices.
The various prudential measures do not address the underlying supply-demand issues. But they
can reduce the risk from the financial side of the housing market while the underlying issues are
addressed. These prudential measures help lessen the amplification of the cycle we get from
borrowing and reduce the risk of developments on the financial side weakening the resilience that
our economy has exhibited for many years. Ideally, this would be achieved by financial
institutions acting themselves, without the need for prudential guidance. But sometimes
prudential guidance can help the whole system adjust.
The calibration of this guidance is not precise or straightforward so we need to keep matters
under review. The Council of Financial Regulators will continue to assess how the system
responds to the various measures so far. It would consider further measures if needed. As I have
said, though, in the end addressing the supply side of the housing market is likely to prove a
more durable way of dealing with the concerns that people have about debt and housing prices
than detailed supervisory guidance.
So that is enough on debt and housing.
Before finishing, I would like to recognise that tomorrow we are having the official opening of our
new banknote distribution centre and vault at Craigieburn, in outer Melbourne. This new centre is
an important investment for us in Victoria. It will help us manage the task of issuing and storing
banknotes nationally for many years to come. The new facility is built around a very large vault
and as you can imagine, it is highly secure. It also uses the latest technology and is our first
major investment in banknote storage and distribution for decades.
As I hope you are aware, we are currently in the process of upgrading our banknotes to stay
ahead of counterfeiters. Counterfeiting rates in Australia remain pretty low but they are creeping
up. The new $5 note came out in September last year and the public reaction has been
favourable. We are proud of these new notes, not just of the design but also of the high-tech
security features. The new $10 will be issued from September and the $50 next year.
As you can imagine, issuing a new series of banknotes is a huge logistical exercise. There are
currently 1.5 billion individual banknotes on issue. That averages 62 per person in Australia. We
also hold large contingency stocks, which we needed during the financial crisis when the
demand for banknotes surged. It might come as a surprise to you to learn that, despite all the talk
of a cashless society and electronic payments, the value of banknotes on issue in Australia,
relative to GDP, is the highest that it has been in 50 years. Australians have come to rely on our
secure and high-quality banknotes. Our new state of the art facility at Craigieburn will help us
manage the storage and distribution of these notes.
Thank you and enjoy your dinner and conversation.