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Wednesday, September 03, 2008

Who wins from lower rates?

The losers are hard to find
There are around 7 million households in Australia. Only 2.5 million will benefit directly from the cut in mortgage rates.

At the 2006 census another 2.5 million owned nothing on their homes. Another 2 million were renting.

This larger group will receive no direct benefit from the cut in mortgage rates. For some, of them it’ll eat into the income they earn from their bank.

But their pain can be overstated. These days a surprising number of Australians earn money from corporations. They are part owners, either through the share market, through managed funds or through superannuation funds.

They’ll benefit as a result of those corporations finding it cheaper to borrow and that benefit is likely to bolster the share price and dividends of those corporations by more than it harms their earnings from deposits.

And in any event deposit rates are still high...

It’s still possible to earn 7.5% if you put in $5,000.

The Treasurer is right to say that the Reserve Bank’s cut is “very welcome news for Australian families and the Australian economy.”

But it carries with it risks.

The last time interest rates were cut in late 2001 new homebuyers rushed to the banks and pushed up new home loans 20 per cent. Home prices took off and took years to cool down.

The then Treasurer Peter Costello welcomed the cut by saying it would “represent a saving on a $100,000 loan of about $20 a month”.

That’s right - a $100,000 loan. House prices were tiny then.

Today’s cut will save a typical Victorian mortgage holder owing $256,600 around $44 a month.

If it does ignite another house price boom it’ll end up hurting renters and encouraging yet another shift in wealth to Australians who already own or are buying houses.

That’s possibly one of the reasons why the Reserve Bank is taking things very gently this time. There’s nothing in its statement to suggest that there will be an automatic follow-up cut.

Another reason might be the Australian dollar. It plummeted an extraordinary 2 cents yesterday on the back of the Reserve Bank’s move and weaker commodity prices. The bank will be watching the dollar and its likely effect on inflation closely.

In Reserve Bank language, its future actions will be “data dependent”. If this interest rate cut causes a problem there won’t be a quick follow up.

For the moment most households have something to celebrate – even many who think they don’t. Home loans are cheaper, corporate borrowings are cheaper, petrol is much cheaper (until the lower dollar kicks in) and tax cuts and improved childcare rebates have given most wage earners more take home pay.

It’s hard to find too many losers.