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The RBA is in a bind – what’s going to happen to interest rates?

Last week RPData made some insightful comments in their blog about our economy, interest rates and how this affecting property markets.

As a property investor this is one blog you should read…Cameron Kusher RPData’s senior research analyst said…

It is obvious that the Reserve Bank (RBA) is currently in a very tough predicament.

While much of the data is proving to be quite negative and providing a clear case for interest rate cuts, every now and then other pieces of data highlight that perhaps things aren’t so bad.

Most notable of these data releases was the labour force data which despite most economists expecting an increase to the unemployment rate it remained at 5.2% and the participation rate actually increased.

As most people will know, official interest rates are currently sitting at 4.25%.

Now over the past 20 years, the cash rate has sat at an average of 5.15%, much higher than its current setting.  Although the cash rate is at above average levels, standard variable mortgage rates are sitting at 7.4% which is fairly close to the 20 year average level (7.35%).

In recent years the major banks have sought to de-couple mortgage rates from official interest rates.

As a result, we now have a situation where the official cash rate is almost 100 basis points below the long-term average however; mortgage rates are sitting at average levels.  As a result, the amount by which the RBA is able to influence repayments on our largest asset class (housing) has been lessened over recent years.

Looking at the RBA website, their official role is detailed at this link.  A lot of the data suggests that we are pretty close to full employment and that we still enjoy economic prosperity and welfare.

However, many would argue that the current high currency is providing instability.  Although these are stated as their official role, in their agreement with Federal Government this ostensibly means keeping inflation between 2% and 3% over the economic cycle.

So looking at inflation and keeping in mind new data will be out later this month, headline inflation is currently recorded at an annual rate of 3.0%.

The RBA’s preferred measures of ‘underlying inflation’, the trimmed mean and weighted median are both well within the target range, recorded at 2.6%.

The most recent data available shows that headline inflation is at the top end of the target range (but it is falling) and underlying inflation is right around the middle of the band.

Obviously the RBA is concerned about inflation and with good reason.

Glenn Stevens was made Governor of the RBA in September 2006 and since December 2006, headline inflation has been recorded at an average of 3.0%, right at the top of the target band.

More concerning is the fact that the RBA’s preferred measures have been recorded at an average of 3.2% (trimmed mean) and 3.5% (weighted median).

Given this, it is no real wonder that the RBA decided not to cut interest rates this month. The RBA’s track record of hitting their inflation target has not been strong and they want to be as sure as possible before making any decision.

As I see it, it is fairly clear cut that another interest rate cut is required to help the economy, particularly if you take just a quick look at some of the recent negative economic data releases:

1. GDP – Australia’s economy continues to grow however, it is growing below the long-term trend

2. Property values – despite a stabilization over the first quarter of 2012, they are down -4.4% over the year

3. Consumer sentiment – the index continues to fall with pessimism outweighing optimism and the index is -10.2% lower than at the same time last year.

4. Business conditions – improving but still not particularly strong

5. Building approvals – continue to weaken and are -15.2% lower than they were at the same time last year

6.Housing finance data:

  • When refinances are removed the value of finance commitments has risen by just 1.7% over the past year
  • The number of non-refinance commitments remains at low levels and has increased by just 3.6% over the year
  • Retail trade – remains quite sluggish having increased by just 2.0% over the past year
  • Growth in demand for credit by the private sector remains benign:
    • Total credit has risen by just 3.5% over the past year
    • Housing credit has risen at an historic low rate of 5.3% over the year

Of course, times have changed in the Australian economy; consumers are saving again and credit isn’t as freely available as it used to be.

Although the Australian economy hasn’t entered into a recession it certainly seems that our mind set has changed and we are at least trying to be less reliant on borrowed money.  What that is likely to mean is that property values, building approvals, housing finance, retail trade and credit demand will grow at levels lower than those we have become accustomed to.

In saying this, just because the consumer mindset has changed it doesn’t mean we have to have a recession.

In my mind, we will see an interest rate cut next month as long as inflation is within the target range.

However, I don’t envy the RBA’s position, although a lot of the economic data looks bad they have been caught out before.

The significant growth in the mining sector is boosting the overall economy, the unfortunate thing being that most of us aren’t reaping these benefits.

Factors such as falling property values and lower levels of construction feed back in to consumers showing less inclination to spend which in-turn feeds back in to lower levels of consumer and business sentiment.

If we aren’t careful it could also lead to higher levels of unemployment and lower levels of economic growth or even a recession.

Let me know what you think.

Was the RBA right to leave interest rates on hold and do you think they will do so again next month?

Source RPData



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Michael is a director of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and his opinions are regularly featured in the media. Visit Metropole.com.au


'The RBA is in a bind – what’s going to happen to interest rates?' have 3 comments

  1. Avatar for Property Update

    April 18, 2012 @ 7:33 am Harold Todd

    I do not understand the comment that most of us are not reaping the benefit of the mining boom. The resultant high dollar allowing us to export inflation, buying cheaper from overseas. Also keeping unemployment at low levels through services sectors feels like most of us are reaping the benefit. I think the RBA will not reduce interest rates until unemployment shows signs of rising.

    Reply

    • Avatar for Property Update

      April 18, 2012 @ 7:44 am Michael Yardney

      Thanks for the comment Harold
      I guess what they’re suggesting is that we have a 2 speed economy – some of us are doing well, but most Australian’s are feeling the benefit yet.
      However I agree with you that we are all benefiting. Only today the IMF said Australia’s economy is outpacing all other developed nations.
      By the way…I think we’re importing inflation, not the other way around.
      Thanks for reading my blogs and commenting

      Reply

  2. Avatar for Property Update

    April 18, 2012 @ 12:05 pm Julie

    As a home owner/property investor the RBA is always wrong when it does not lower interest rates! What do you think will be the effect on inflation of the Carbon Tax when it comes into being in July 2012? If prices and costs rise for businesses and households could that mean higher unemployment and higher inflation?

    Reply


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