The game theorists must be having a field day with the competing thoughts and processes that Westpac, the other majors, second tier banks, mutuals and the Reserve Bank are going through at the moment in the wake of the surprise move by Australia’s second biggest home loan lender to raise rates on its mortgage home loan book by 0.2% this week.
But while the game theorists are fascinated with the many permutations rolling around Reserve Bank headquarters at Martin Place and the various other head offices around the country, financial markets took the simple route.
That is, they just reckon it means the RBA will need to cut rates again.
The logic is fairly sound in many ways because traders are simply guessing that the Westpac hike will probably be followed by the other big banks. That will then tighten financial conditions in the economy and the Reserve Bank will then need to cut rates.
And, it’s logic that Bill Evans, Westpac’s chief economist, tacitly agrees with in a note released this afternoon. Evans says:
“We conclude that based purely on history the most likely outcome is that financial conditions are likely to tighten further.”
That’s a nice way of saying that all the big banks will probably follow Westpac’s rate rise with moves of their own.
Evans says his study of history of the out-of-cycle moves by the big banks since the GFC tells him the RBA is likely to readjust rates for this tightening. But, he adds that they will need to see evidence of the size of the tightening and the impact on the economy before they move.
That seems fair and follows the RBA’s normal practice.
But Evans also introduces his own thoughts on the endless game theory possibilities of any such cut by the RBA.
He notes the RBA will need to be mindful of the impact of a cut on the broader spectrum of interest rates including business loans and deposits. A cut, he says, could therefore lead to a net easing of monetary conditions of the economy given these factors beyond just home loan rates.
But in a further complication to this game, Evans introduces a new, but obvious, complicating factor. He wonders on what the RBA wonders the banks might do if the RBA cuts again:
“The Bank will have another degree of uncertainty associated with the degree to which the banks pass on any rate cut. These issues will be weighed by the RBA in making its policy decision.”
In the classic game theory cake experiment, it’s akin to the question: “If I cut my slice this big, what slice will I get when you guys have all had your slice?”
But, in the end there are just too many parts and players moving all at once and Evans says that means it’s too early to make the call that RBA will cut rates in response to his bank’s move to tighten rates.
“We expect that the RBA will await this information on the effective change in financial conditions before making a decision as well as assessing any early signs of the impact of this tightening on the economic outlook.
When this information becomes clearer we will reassess our current view, which, at this stage is for no policy change in 2015 or 2016.”
But it sounds very much like he thinks the RBA will cut rates eventually.