Before heading out the doors for Christmas, the Reserve Bank of Australia (RBA) board indicated “on present indications, the most prudent course is likely to be a period of stability in interest rates.” The last time the RBA had taken the knife to interest rates was on the 7th August 2013, some 16 months earlier. Australia’s central bank was anticipating on keeping the last remaining and precious 10 official cash rate cuts left in the war chest for the next crisis, at the envy of so many other central banks presiding over failed debt fuelled crises with cash rates sitting at zero.
But in a surprise and sudden move, the Reserve Bank decided yesterday it had no choice but to act against a backdrop of a rapidly deteriorating economy, and in the process, risk putting the icing on the world’s largest housing bubble.
Outside of a brief mention on a strengthening US economy, yesterday’s statement by RBA Governor Glenn Stevens on the monetary policy decision was packed full of doom and gloom.
It indicated the Eurozone economies and Japan were “both weaker than expected” and “China’s growth was in line with policymakers’ objectives” – which is a positive way of saying China’s growth rate came in at 7.4 per cent in 2014, the lowest figure in 24 years and the first time the country missed its growth target in 17 years.
China’s decline after an insatiable appetite for commodities is causing havoc for world commodities prices, a pain almost unbearable for Australia who bet its entire future on China and the triumphant “100 year” resource boom. The Reserve Bank noted “commodity prices have continued to decline, in some cases sharply.” Our largest export, iron ore is down 46 per cent in 12 months. In a post in January (Falling back to earth – Our terms of trade collapse) we showed what affect this is having on our terms of trade and what this will mean for wage growth and jobs – or more precisely lack off – going forward.
One potential positive is the significant decline in world oil prices, with the RBA noting it will “temporarily” lower CPI inflation before the falling dollar erodes any benefit.
Domestically, the RBA suggests growth is “continuing at a below-trend pace” with an emphasis on domestic demand growth being “overall quite weak” causing unemployment to rise over the year.
One possible driver for the surprise decision to cut could be the stubbornly high Aussie dollar. The central bank notes even with the recent 18 per cent plunge in the past 6 months, the Australian dollar still remains above its “fundamental value, particularly given the significant declines in key commodity prices.”
And Australia’s much hyped housing bubble featured predominately with the bank noting credit growth has picked up, with “stronger growth in lending to investors in housing assets” (Sydney investor led housing bubble irrefutable) and noting the surge in dwelling prices in Sydney. Dr Andrew Wilson from the Domain Group recently reported Sydney house prices are in “hyperdrive” after prices surged an unsustainable and very dangerous 29 percent in just two years, out-striping CPI and wage inflation several-fold.
Yesterday’s rate cut is only likely to fuel what the RBA’s “central bank”, the Bank for International Settlements (BIS) last year reported was the world’s second most expensive housing market in the world (Australians struggle with world’s second largest housing bubble), behind oil exporter Norway.
The RBA tries its hardest to allay concern saying it “is working with other regulators to assess and contain economic risks that may arise from the housing market.” We reported last year, (Property bubble a Macroprudential challenge for regulators) that the Council of Financial Regulators, who is chaired by the Reserve Bank of Australia, is working on Macroprudential controls in a bid to contain the bubbling housing market. In December, hot on the release of the Murray report, the watch dogs started to bark – but have yet to bite (Woof – The watchdogs have a bark!)
As we reported then, it is widely expected the regulators will decide to impose capital charges on higher risk investor loans, especially interest only loans. This would require the bank to hold more loss absorbing capital and would likely pass this cost on to the property investor though higher interest charges without effecting owner occupiers, the diminishing first home owner or business. However, recent indications is such framework will be delayed until later this year only exacerbating the current concerns.
The latest statistics from the Reserve Bank, prior to this rate cut, show households are once again starting to leverage up after the period of stability in interest rates when they should be trying to de-leverage and de-risk. Total household debt as a percentage of household disposable income is just 0.4 per cent from the peak during the 2008 GFC. The majority of household debt is locked in residential housing which is at a record high of 139 per cent of household disposable income.
This unprecedented and significant run up in debt over the past 25 years is why the Australian economy is in the doldrums now – and why so many economies collapsed in 2008. Despite having a larger housing bubble than the US in 2007, Australia masked and delayed the devastating effects though an unprecedented mining bubble flooding the country and households with excess money – through middle class welfare, high wage growth and monumental investment returns. Worst still, Australian’s became complacent as the ‘miracle economy’ was tossed around. The recent collapse of the mining bubble, now leaves Australia’s household debt greatly exposed and potentially the next domino to fall as jobs are lost and loans become unserviceable. Only today, Bloomberg reported to the world, “This is what an economic hangover looks like. More offices lie empty in Perth, Australia, than at any time since 1996, while the number of homeowners seeking to offload properties has surged 45 percent from a year ago.”
This is not the time for the average Australian to be complacent on interest rates at levels not seen since the 1950s. To illustrate the significance of the household debt bubble, figures from our National Accounts (ABS) show households still allocate more of their household disposable income to interest on dwellings today, than in 1989 when interest rates peaked at 17 per cent. Low rates have been offset by astronomical household debt levels.
It also goes a long way to explain why domestic demand growth is “overall quite weak” according to the RBA. With so much capital misallocated to housing/shelter and the high cost of living, there is little disposable income left to underpin consumer spending and create jobs to fill the void from the mining boom.
While the Reserve Bank would like you to be out spending, the best thing Australians can do now is to start paying down that white elephant – household debt – and as fast as they can. According to interviews of the indebted, conducted by one of the television news services tonight, that is exactly what people intend to do.
And to finish with some light comical relief, shortly after the announcement of the rate cut, Treasurer Joe Hockey said the rate cut, caused by a rapidly slowing economy, was “good news” – While the decision was solely a matter for the RBA, his government contributed to the cut by keeping inflation low, even going as far to confidently state there will be further cuts to come. While, I suspect he didn’t bother reading the governor’s gloomy statement following the decision, and I know for sure Hockey doesn’t control world oil prices, you wonder if there is an ounce of truth about his contribution. Is the current political circus etching away at consumer & business confidence? I have no doubt it has some role to play.
» Statement by Glenn Stevens, Governor: Monetary Policy Decision – Reserve Bank of Australia, 3rd February 2015.
» Mining Bust in Perth Shows Damage That Led Australia to Cut Cash Rate – Bloomberg, 3rd February 2015.