RBA pre-emptive policy and mounting moral hazard
Australia’s Reserve Bank continues to deploy a pre-emptive policy strategy, easing policy when expecting below-trend growth and/or below-target inflation. In a speech last week, RBA Governor Philip Lowe indicated that official rates, already cut from a record low 1.5% to 0.75%, could be lowered to a mere 0.25%; though he set a higher bar on adoption of quantitative easing.
The RBA’s recent stimulus appears to have reignited the housing bubble and pushed equity valuations to the second highest on record – but so far it has failed to reignite the real economy.
In our view, the RBA’s continued pre-emptive policy strategy, continued at emergency rate levels, is intensifying moral hazard, encouraging risk-taking in the belief that the RBA will always bailout weak property markets. This is Australia’s version of the Greenspan “put” (now called the Powell “put”) where markets expected the US Federal Reserve’s chair to always ease policy to rescue a weak equity market. An outcome of this policy strategy in the US was the Technology, Media and Telecoms (TMT) equity bubble of 1999-2000 and the housing bubble of 2007-08.
In Australia’s case this policy has driven extremely high household debt levels and very inflated asset prices, with home prices back near record levels and the ASX 200, on a forward PE above 17x, a level only exceeded in 1999-2000. The ASX 200 Industrials ex-Financials is at a record valuation (Figure 1). But rate options are now exhausted, with the cash rate at-or-around the zero bound. Australia is out of monetary policy options should we see a China downturn, a full-blown trade war or domestic downturn – not our forecasts, but real possibilities.
Investment implications: With the RBA out of conventional policy options, investors should be very wary of chasing record Australian asset prices. We see lower risk, less expensive options in international equities.
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