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BFC2000 Assignment Faisal Bashari, Nipun Arora




Reserve Bank of

Australia Report-

BFC2000 Assignment

Faisal Bashari - 24231711

Nipun Arora - 24154784

Word Count: 1619

Due Date: 18th

Sep 2014




The Reserve Bank of Australia’s (RBA) monetary policy through the implementation of the

cash rate plays an integral role in maintaining a strong Australian financial system. The cash

rate should be set such that the three primary roles of the RBA are met. These include:

inflation being kept in the 2-3% bound as this achieves most optimal growth in Australia;

maintaining full employment and maximising the economic prosperity and welfare of

Australians. Therefore, when deciding on the appropriate cash rate, both domestic and

global environment need to be considered. Dwelling investment is one of the major sectors

of Australia’s financial market and there is great heat from this factor warranting an

increase in the cash rate. On the other hand, a decrease in the cash rate seems more

suitable when looking at solely the domestic economy and in particular the mining and non-

mining investments. Lastly, on the global scale, Australia’s closest trading partners are

experiencing higher than historical growth and a low cash rate allows the full benefit of their

success to be experienced by the Australian economy. Thus, while the pressure of inflation

merits for an increase, ultimately, the RBA should sustain the current cash rate of 2.5% so as

to ensure maximal investment in the Australian economy.

The performance of domestic financial markets is a significant determinant of the target

cash rate. The criterion based on RBA meeting (RBA, 2013) signifies that one of the best

indicators of future performance that reflects the sentiment of the Australian economy is

the performance of the real estate market in Australia. Currently, the heated housing

market in Australia has been critiqued as a ‘bubble’. In the three months to august alone,

prices rose 4.2% (Mark Mulligan, 2014)(Figure 1a) the largest rise in 18 years according to

Residential Property (RP) Data figure. Additionally, the construction and property

management industry witnessed the biggest increase in confidence over the March Quarter,

rising to 31.5% due to the huge flock in investors and first homeowners demanding new

dwellings (Robershaw, 2014). Figure 1b reflects the upward trend in the overall business

index, which can be significantly owed to the strengthened confidence within the

construction industry. The rising number of investors in the real estate market is also

reflected by the fact that 60% of bank loans are for housing purposes especially for the

construction of new houses (Pelosi, 2014). The problem with this continual rise in housing

prices is inflationary pressures. Thus, to curb the growing inflation rates, it would seem arise the cash rate is necessary. If interest rates were to rise as a result of increase in cash




rates, it would be safe to assume that the property market would cool down, as property

investment would no longer as attractive. However while the inflation is still within target,

sitting on 3% (Figure 1c), such a move would dampen consumer sentiment levels and slow

down the economy (Pelosi, 2014) owing to the extreme volatility of borrowers to changing

interest rates. Furthermore, such a move may not be needed as according to the Melbourne

Home Price Index, an increase in the supply of property influences house prices by slowly

depreciating its value (Orren, 2003). Evidently, RP Data from April shows that although the

number of auctions decreased, the total supply of houses did in fact grow as can be seen by

the growth of loans for construction purposes (RP Data, 2014). The phenomenon above

demonstrates that the housing market may in fact be in the phase of self-correction. Thus,

the recommendation is that an increase in cash rate is currently not needed and doing so

could potentially damage to the stability of the economy.

In addition to the domestic financial markets, it is crucial to also consider domestic

economic conditions, which play a significant role in maintaining economic prosperity and

stability of prices. One of the key determinants of domestic economic condition within the

Australian economy is the performance of the resource sector. The resource sector

represents a large proportion of Australia’s export industry, as shown by Department of

Foreign Affairs and Trade who rank Australia’s top 3 exports as iron ore and concentrates

(21.82%), coal (12.50%) and Education-related travel services (4.72%) (Department of

Foreign Affairs and Trade, 2014). However, recent figures show that investment in the

resource market is declining as the resource sector transitions from its investment phase to

the production phase (RBA, 2014c). On the other hand, the Capex report shows that

expectations for investment in non-mining sectors have picked up, implying a solid growth

of around 7% in 2014-2015 (Research ANZ, 2014) (Figure 2a). Hence, RBA is likely to be

encouraged by the growth in non-mining investment activities at the current cash rate.

Furthermore, the reason for firm’s reluctance to undertake significant investment projects is

that a sustained period of strong demand in the domestic economy has yet to be witnessed.

Thus, an increase in the cash rate, which will steer the interest rate up, will only deter the

potential investors away from investing in the non-mining sectors and thus have an impact

on the projected economic growth of Australia. On the other hand, a decrease in the cash

rate to provide further stimulus and therefore, decrease unemployment is also not needed.

This is because it will be some time before we see a consistent decline in the unemployment




rate (RBA, 2014a). The slow movement in the unemployment rate can be contributed to the

spare capacity in the labour market. One of the possible explanations of spare capacity in

the labour market can be contributed to the shift of demand of labour from the resource

sector to the non-mining sector. As the non-mining sector gears up, the spare capacity in

the labour market can be attributed to the delay until the non-mining sector is well

established and thus, new jobs are created in the economy (Kent, 2014) (Figure 2b).

Nevertheless, some signs of improvement in unemployment emerged as in August

unemployment fell for the first time since the beginning of the year. Hence, as already

noted by Glenn Stevens, governor of the RBA, a revival in non-mining sector should

automatically stabilise the economy and treat the issues of unemployment. Thus, no change

in the monetary policy is needed to achieve this goal.

The view of a sustained cash rate is further supported when looking at the economic

conditions of Australia’s closest trading partners. Australia’s trading partners are forecasted

to have a slightly above long-run average growth of 4.25% in both 2014 and 2015 (Figure 3a).

GDP growth for China is expected to be around the authorities target of 7.5 % and while this

is weaker than previous years, it is still well above its historical average. However, there

remains some risk to the outlook for China due to the declining growth of fixed asset

investment and the weakening residential property market (RBA, 2014b). Thus, problems

may arise in the future for the Australian economy, as we are highly dependent on the

Chinese economy. This is evident by the fact that 23.3% (Department of Foreign Affairs and

Trade, 2014) of Australian exports are destined for China. Japan’s GDP growth suffered a

similar fate after the introduction of the consumption tax in April. The contraction of output

for Japan resulted in ease in the pace of growth, as on a quarterly basis GDP growth fell by

1.8% for the quarter ending August. Japan’s economy last suffered a hit of this magnitude

after the 2011 tsunami and nuclear disaster (Riley, 2014). However, it is too early to judge

the likely pace of growth over the complete second half of this year (RBA, 2014a). Therefore,

this decline may not be detrimental to the welfare of the Australian economy. On the other

hand, the US economy is growing moderately after recording a strong rebound in growth in

the June quarter (RBA, 2014b). The housing market has grown by 9% as compared to last

year. Along with the housing market, the employment conditions have improved

significantly in terms of the overall increased strength of the labour market over the six

months to July. Consequently, the strong labour market has decreased the unemployment




rate and has also improved the participation rate as compared to the commencement of

global financial crisis. Growth in the economies of Australia’s closest trading partner means

that they will be willing and be able to demand Australian exports. Therefore, as global

financial conditions still remains very accommodative (RBA 2014a), the highe economic

activity and investment into Australia helps achieve full employment as well as ensuring

economic prosperity. Accordingly, monetary policy should be such that it affects next

exports in a positive manner. Thus, the recommendation is that the cash rate should remain

unchanged at this low level as it is appropriately set to fully benefit from the success of our

trading partners.

In conclusion, the Board should leave the cash rate unchanged to foster sustainable growth

in demand and inflation outcomes consistent with the target. This is due to the strong

performance of the housing markets in terms of rising local house prices being matched

with the soaring home building approvals. Conversely, no change in the cash rate would

best suit the domestic economy as several forces are counteracting with each other,

although arguments of needing a cut could be put forward. Finally, an examination of

Australia’s major trading partners concludes the discussion and deems that the best course

of action is to not alter the cash rate at present. The decision above takes into consideration

the dominant influences that has encouraged RBA in their previous cash rate decisions,

which were in a common environment. Ultimately, the decision above aids RBA in using the

tools of monetary policy to achieve its key goals.




Appendix – List of Figures

Figure 1a: Retrieved from http://www.rba.gov.au/chart-pack Figure 1b: retrieved from https://www.commbank.com.au/about-

us/news/media-releases/2014/business-confidence-remains-strong-

despite-slight-easing-from-record-high.html

Figure 1c: Retrieved from http://www.tradingeconomics.com Figure 2a: Retrieved from https://bluenotes.anz.com

Figure 2b: Retrieved from http://www.rba.gov.au/speeches/2014

Figure 3a: Retrieved from

http://www.rba.gov.au/publications/smp2014

Figure 2c: Retrieved from

http://www.tradingeconomics.c

om/australia/unemployment-rate




Reference List

Department of Foreign Affairs and Trade. (2014). Composition Of Trade (p. 1, 41). Canberra:

Department of Foreign Affairs and Trade.

Kent, C. (2014). Non-mining Business Investment–

Where to from here? . Speech, BloombergEconomic Summit.

Mark Mulligan, M. (2014). Melbourne, Sydney lead winter house price surge. Sydney Morning

Herald , p. 1. Retrieved from http://www.smh.com.au/business/melbourne-sydney-

lead-winter-house-price-surge-20140901-10atwd.html

Orren, T. (2003). House prices and interest rates. Australia: Productivity Commission.

Pelosi, J. (2014). How do interest rates impact the property market? | MyWealth

Commonwealth Bank . Mywealth.commbank.com.au. Retrieved 17 September 2014,from https://www.mywealth.commbank.com.au/property/how-do-interest-rates-

impact-the-property-market--hottopic201408

Reserve Bank of Australia. (2013). Minutes of the Monetary Policy Meeting of the Reserve

Bank Board . Retrieved from http://www.rba.gov.au/monetary-policy/rba-board-

minutes/2013/03122013.html

Reserve Bank of Australia. (2014a.). Minutes of the Monetary Policy Meeting of the Reserve

Bank Board . Retrieved from http://www.rba.gov.au/monetary-policy/rba-board-

minutes/2013/03122013.html

Reserve Bank of Australia. (2014b.). Economic Outlook . Retrieved from

http://www.rba.gov.au/publications/smp/2014/may/pdf/eco-outlook.pdf

Reserve Bank of Australia. (2014c.). Domestic Economic Conditions. Retrieved from

http://www.rba.gov.au/publications/smp/2014/feb/html/dom-eco-cond.html

Research, Anz. (2014). Transition to a non-mining Australian economy on track - See more at:

https://bluenotes.anz.com/posts/2014/08/transition-to-a-non-mining-australian-

economy-on-track/#sthash.xPEeyaIT.8Ht6KqG8.dpuf . ANZ Research. Retrieved 17September 2014, from RBA,. (2014.). Economic Outlook. Retrieved from

http://www.rba.gov.au/publications/smp/2014/may/pdf/eco-outlook.pdf

Riley, C. (2014). Japan GDP growth collapses amid sales tax shock . CNNMoney . Retrieved 17

September 2014, from http://money.cnn.com/2014/08/12/news/economy/japan-

gdp/

Robershaw, C. (2014). Confidence among property and construction firms at record highs.

BLOG Business. Retrieved from https://www.commbank.com.au/blog/confidence-

among-property-and-construction-firms-at-record-highs.html




RP DATA. (2014). Capital city housing market records strongest capital gain for winter since

2007. Retrieved from

http://www.rpdata.com/research/capital_city_housing_market_records_strongest_ca

pital_gain_for_winter_since_2007.html

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