Reserve Bank softens up borrowers for "neutral" cash rate of 3.5 pc; A$ surges

The Reserve Bank is continuing its campaign to soften up highly leveraged borrowers for eventual interest rate rises after a long period at record low levels.

The central bank is now busy estimating what a "neutral" interest rate might look like as the Australian economy continues to show patchy signs of recent strength.

In the minutes from its July meeting a fortnight ago when rates were left on hold at 1.5 percent, the RBA has signalled that to keep growth and inflation in check the "neutral nominal cash rate" would need to rise to around 3.5 percent.

The minutes show the RBA's pursuit for a "goldilocks rate" - not too high or too low - comes as as central banks around the world such as the US Federal Reserve signal conditions are right to slowly raise rates from emergency levels.

The predictions for a higher cash rate will put investor and residential borrowers on alert given high levels of loans issued at the record low cash rate.

"All estimates of the neutral real interest rate for Australia suggested that monetary policy had been expansionary for the previous five years or so," the minutes say.

"A reduction in risk aversion and/or increase in the potential growth rate could see the neutral real interest rate rise again.

"A number of central banks had become more positive about domestic economic conditions, and financial market pricing suggested that there had been upward revisions to the expected path of future monetary policy."

The RBA noted that despite slower economic growth in the March quarter, key indicators such as the labour market, wages growth and retails sales had been gradually improving in Australia.

Although the Australian Prudential Regulation Authority (APRA) has been cracking down on banks to maintain a cap on investor loans, the RBA says it is too early to assess their full effect.

While the July meeting was held before the recent resurgence of the Australian dollar, the minutes show the economy remains exposed to any spike against the US currency.

"The depreciation of the exchange rate since 2013 has assisted the economy in the transition from the mining boom," the minutes say.

"An appreciating exchange rate would complicate this adjustment."

Reserve Bank members are also concerned about rising wholesale electricity prices in the first half of 2017.

"This has led to significant increases in the context of efforts to address climate change and to alter Australia's energy mix," the minutes say.

"Concerns about energy security , reliability and costs has been heightened .. partly reflecting policy uncertainty."

Despite the RBA's efforts to manage expectations, concerns remain that anything but a gradual increase would leave indebted borrowers in Sydney, Melbourne and Brisbane potentially exposed to rising repayments.
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