RBA governor Philip Lowe has explained the central bank’s position on interest rates and clarified the 3.5 per cent neutral rate comment that triggered a strong reaction from financial markets last month.
The minutes of the Reserve Bank’s July monetary policy meeting stated that board members discussed the RBA’s work estimating the neutral real interest rate for Australia.
The minutes stated: “The various estimates suggested that the rate had been broadly stable until around 2007, but had since fallen by around 150 basis points to around 1 per cent. This equated to a neutral nominal cash rate of around 3.5 per cent.”
Markets reacted strongly to the news, released on 18 July, which led AMP Capital chief economist Shane Oliver to state on 21 July that the reaction to the minutes “was way over the top”.
RBA governor Philip Lowe was questioned about the rhetoric of the minutes during his appearance at the House of Representatives Standing Committee on Economics in Melbourne on Friday.
“For a period there was some misunderstanding about our intentions when talking about the neutral rate,” Mr Lowe admitted. “At those meetings, the board has a discussion about a certain topic. It could be deep dive into part-time employment, into developments in China and the Chinese financial system and obviously a few months ago on the neutral real interest rate.
“We decide these topics a month, often a year in advance, and we work through them. We decided perhaps at the beginning of this year to have a discussion about the neutral real rate. We had those discussions and the minutes reflect that.”
However, around the same time as the RBA minutes were released, central banks across the globe started changing their rhetoric around monetary policy, which Mr Lowe believes added to the misreading by markets.
“The Bank of Canada increased its rate and the ECB said they were perhaps not going to do quite as much expansion as before, and some of the Nordic central banks had changed their rhetoric as well,” he said.
“I think what happened was that the market incorrectly took the fact that this was in our minutes as a signal that we were about to join that club. That was not our intention.
“There shouldn’t be any particular significance read into that. I think the market now understands that we have these discussions and [the] short-term effect of that discussion has been unwound now.”
Former RBA member John Edwards predicted in late June that the central bank could lift rates by eight times within two years.
“[The RBA] would think of a sustainable or natural policy rate as at least 3.5 per cent and, most importantly, it will want the policy rate increase to match the forecast improvement in Australia’s economy performance, so it will want to be at 3.5 per cent (at least) by the end of 2019,” he said.
In line with the hikes, the average standard variable rate on home loans will rise from 5.3 per cent to 7 per cent or more, Mr Edwards forecast.
On Friday, the RBA governor confirmed that "the average level of interest rates in the future will be higher than it is today".
[Related: Housing resilience puts pressure on APRA]