Wednesday, February 04, 2015

The economy is weak. It's why the Reserve Bank cut

Pay no attention to what the Treasurer says this time. Listen to what he said last time.

Two years ago under Labor when the Reserve Bank cut rates, Joe Hockey said it was a sign the economy was struggling.

He tried to say on Tuesday that this time things are different. That the economy isn't struggling because inflation is low.

But inflation has been low in the past when the Reserve Bank has cut rates because of economic weakness, in one case even lower than it is today.

The Reserve Bank cut rates on Tuesday because the economy was growing "below trend". It said so, in the statement issued after the meeting.

While the collapse in petrol prices was containing costs (good news), the collapse in export prices was containing income growth (bad news). The net effect would be a further rise in the unemployment rate beyond what the bank had previously expected.

Disconcertingly, the bank's statement provided no guidance as to whether it expected to cut again. The omission was deliberate.

The bank will assess what happens as a result of this cut and then decide. If the cut does no more than encourage bigger housing loans and further push up home prices, it'll leave it at that. If it encourages spending and investment it might decide that it's worth doing again.

After the Treasurer spoke on Tuesday, his staff left in the conference room a printout listing 24 countries with lower cash rates than Australia. The message was clear. The Reserve Bank can do more and should do more.

Mr Hockey is unable to do much more... The lower oil price will strip his budgets of expected revenue as it feeds into the price of exported liquified natural gas. His December economic statement said so, but it will need to be seriously updated. Oil prices have fallen far further since then.

The Reserve Bank would rather not have to cut again. It is worried that we will simply take out bigger mortgages. Right now we owe the banks $856 billion in mortgage debt and we owe another $459 billion in mortgages for investor housing. 

The totals dwarf the $353 billion owed by Hockey's government. Fuelling their growth could fuel financial instability. RBA governor Glenn Stevens explicitly said he was working with regulators to "contain economic risks" that might arise from the housing market.

He wants the banks to act responsiblly and do nothing more to encourage overleveraged lending, particularly lending for investment. If they don't he may be unable to give Mr Hockey what he wants; he may be unable to give the economy the further boost it will probably be need.

In The Age and Sydney Morning Herald

Hockey says shackles are off as Reserve Bank cuts interest rates to 55-year lows

Declaring "the shackles are off the Australian economy", the Treasurer Joe Hockey has embraced the first in what might be a series of Reserve Bank interest rate cuts, saying it has room to cut again.

On Tuesday the Reserve Bank of Australia cut its so-called cash rate from 2.50 to 2.25 per cent, the first such move in 18 months. The cash rate is now the lowest since 1959, before three quarters of the present Australian population was born.

Two small banks, the Bank of Queensland and ME Bank, immediately passed on the cut, cutting their flagship mortgage rates to 5.13 per cent and 4.62 per cent. It's the first time advertised mortgage rates have been below 5 per cent since the 1950s.

RBA governor Glenn Stevens cited "below trend" economic growth and "quite weak" domestic demand as the reasons for the cut.

The RBA's economic update, to be released on Friday, will mark down its previous forecast of economic growth of 2.5-to-3.5 per cent during 2015. The markdown will be less severe than if the bank hadn't cut rates, because its forecasts will incorporate the economic boost it expects the cut to deliver.

The Australian dollar tumbled more than one and a half cents on the cut, hitting a fresh five-and-a-half year low of US76.57 cents, down from US78.16 cents minutes before.

Despite the sharp fall in the Aussie dollar – nearly 20 per cent in the past six months – Mr Stevens said the exchange rate remained too high.

Mr Hockey welcomed the cut.

"The Reserve Bank has room to move, by us helping to reduce inflationary pressures in the Australian economy. There is no doubt the Reserve Bank has room to move after today," he said.

Financial markets agreed, pricing in a 100 per cent probability of a further cut by May and a strong chance of another cut beyond that.

Hinting that further cuts would be unlikely if the latest cut did no more than push up house prices, Mr Stevens said the bank was working with the Australian Prudential Regulation Authority to assess and contain economic risks in the housing market.

If fully passed on, the cut will mean a drop in mortgage payments of $53 a month for a borrower with a $350,000 loan.

The Treasurer said taken together with the recent cuts in petrol prices, the benefit for such households would be the same as an interest rate cut of 1 per cent.

If petrol prices stay at their present level, families would save around $1000 a year.

"The shackles are off the Australian economy," Mr Hockey said. "I say to Australian business – go out there, have a go, employ more Australians because the costs of doing business is down."

He said he wanted the cut to be passed on in full, particularly for small business owners and to people with credit cards.

Many credit card rates remain close to 20 per cent despite four years of rate cuts. The National Australia Bank said its rates were under review while the ANZ will review its rates on Friday.

In The Age and Sydney Morning Herald

What you’ll pay

New standard rates 

Bank of Queensland 4.62% (down 0.25 points)
Members equity 5.13% (down 0.25 points)
NAB: 5.88% (under consideration)
ANZ: 5.88% (under consideration)
Commonwealth: 5.9% (under consideration)
Westpac: 5.98% (under consideration)

How much you’ll save

If the banks pass it on


$20,000 $3                                  

$40,000 $6                                                                                              

$60,000 $9                                

$80,000 $12                                

$100,000 $15        

$150,000 $23                                

$200,000 $30                        

$250,000 $38                            

$300,000 $45                            

$350,000 $53            

$400,000 $61                      

$450,000 $68                                                

$500,000 $76                        

$600,000 $91                      

$700,000 $106                        

$800,000 $121                          

$900,000 $136                          

$1,000,000 $151  

Assumes 25 year 5.95% variable mortgage  

Related Posts

. Tuesday: Why I expect the Reserve Bank to cut interest rates on Tuesday

. Monday: Economic weakness. Why the Reserve Bank is poised to cut its cash rate on Tuesday

. December 4: Why the Reserve Bank board is poised to cut