Peter Martin predicts that the Reserve Bank will cut interest rates again by at least 0.75%, and possibly 1%, when it meets on December 2.
If you take the pessimistic view, you might argue that the Bank is scared out of its wits by the possibility of a severe recession. If you’re a bit more of an optimist, you could equally take the view that the bank is prepared to do whatever it takes to avoid one. The RBA has already cut official interest rates by 2% since September; a 0.75% cut would take us back to the lowest level since September 2001. According to Martin’s article, the markets are predicting a cash rate of 3.5% by the middle of May, “which would be the lowest level since the 1950s.”
It’s important to keep in perspective just how massive a whack to the economy such cuts are. If it really does get down to 3.5%, that would represent a 3.75% cut in the cash rate. Not all of that is getting passed on to mortgage holders, but if they get a cut of 3%, that represents a cut of $3,000 a year on a $100,000 mortage (in 2002, the average outstanding mortgage debt was $77,000, I couldn’t find more recent figures). That’s $57 a week. On top of that, petrol is down about 50 cents a litre from its peak. The average household petrol usage is around 35 litres; so that’s another $17.50 in the pocket. And there’s nothing to stop the Reserve Bank cutting rates further if it has to. And I haven’t factored in the government’s existing stimulus package, let alone what it might do on infrastructure.
None of this is to discount the risks that Australia faces because of reduced prices for our dirt. But the RBA and the Government can push very hard in the other direction.
And to think, interest rates would always have been lower under a Liberal government! (Johnny told me so it must be true). Where would that leave us? The banks would have been paying us to buy houses!
On a serious note, when I look at those numbers Robert, I can’t help but think that the old inflation genie may just be waiting to spring forth from his bottle in a furious conflagration of wealth-destruction.
They’re just pushing on a string…
When a dirt-based economy busts, it busts big. It should be noted though, that the crash in the AUD means the price we get for our dirt in AUD terms hasn’t fallen near as fast. Mind you, the AUD seems to have bottomed now, and I reckon commodities have a lot further to fall.
Can I put in another plug for this fantastic piece from Kohler today. Its required reading for everyone I reckon: A tsunami of hope or terror?. Please read it!
There is a third view of what the Reserve Bank is thinking, and that is that they have no more idea of what is going on than the lady in the fruit shop.
This doesn’t make Reserve Bank officials incompetent. In normal times they are extremely competent. But what has happened in the past 18 months has not happened before in their life times, if ever.
What’s going to happen when they cut interest rates to zero and the economy is still in a hole? That’s the story of Japan for most of the past 20 years. If it can happen to them, it can happen to us.
Carbonsink: Japan’s malaise was exaggerated by their aging and shrinking population. If you take GDP per capita, they weren’t doing too badly.
You can take the present without believing in Santa. They used to be known as the gnomes of Zurich. Are they now elves?
“Not all of that is getting passed on to mortgage holders”
Not least because many banks only revise automatic payments on an annual basis, as I just found out. I had to explicitly request that our payments be reduced to match the new interest rate – otherwise it wouldn’t have been done until May next year. Of course, what that means is that we’re now paying down less principal, so the loan will take longer to pay off, but at this point it seemed a sensible decision.
Er, I didn’t say anything about Japan that was Spriros.
I just banged on about how fantastic Kohler’s piece on CDOs is and how EVERYONE SHOULD READ IT. BTW, subscription to Biz Spectator is free, and no, I don’t work for them.
Sorry CS, Spiros. I’ll have a look at the CDO piece.
It is actually not a chrissy present for all.
In fact a tranfer of wealth from those with funds invested in term deposits etc to those with a mortgage and the banks, creaming, no matter which way the wind blows.
Many self and part-funded retirees have already been hit hard by the stock market crash. With that and the interest rate fall there will be many forced to claim full pensions and thus more strain on taxpayers, generally.
The Reserve bank has got this all horribly wrong. It was pretty clear even six months ago that the RBA should have moved to an easing bias. Instead it kept jacking up rates at a time when NSW was heading for disaster and Victoria was significantly slowing down.
It was jacking up rates because of high inflation driven by petrol and food. The economy seemed to be going well – but that was only because WA and Qld were powering ahead on the resource boom. Food and petrol inflation cannot be controlled by interest rates – one was a product of the drought, and the other a product of global oil prices.
So the RBA kept stamping on the brake – just before the world economy crashed. In fact – the credit crisis has probably saved it from severe embarassment. It can now claim the looming recession is not their fault!
carbonsink:
The other relevant factor is that a lot of commodities we sell (iron ore is one example) are not priced by the world price at the point of delivery but set by contract well in advance. We’re still being cushioned by the fact that a lot of those contracts were negotiated last year. It’s highly likely that the Japanese and the Chinese will take us to the cleaners in contract negotiations on price for 2009, if that hasn’t already occurred.
Its a another bail out of the high risk takers.
Those who have a high mortgage get bailed out with a interest rate so low it looks like free money. As joe2 said, its with a transfer of money from those who played it sensible and saved cash to those who played fast and loose.
Mark @ 11: BHP is already selling ~30% of its iron ore on the spot market, which is a 40% discount to the contract price.
Thanks for the info, carbonsink.
One question I’ve been wondering with regards to passing on the full amount of interest rate cuts, what would be happening if the Commonwealth Bank hadn’t been privatised? My suspicion is that there would be greater political pressure on Commbank to pass on the full cut and thus force other banks to do likewise.
They need to try for a competitive devaluation. That’s a game that everybody loses once everybody’s playing (as happened in the 30s) but the first to start gets a big advantage in the meanwhile. As in the Asian financial crisis of 1998, if the Aussie dollar drops low enough fast enough people will keep buying our dirt (and package holidays, and food) because it will become dirt cheap (sorry) in their own currency.
Andrew’s right – the crisis has saved the RBA from embarrassment at how dumb their policies were in the last two years. All the high interest rates did was suck in hot money through the carry trade, which of course has promptly fled (causing maximum disruption to our own money markets) as overseas’ investors fear overtook their greed.
And I really can’t understand why the RBA is dropping rates in tranches like this. They must know that rates will have to be way, way down next year, so why not do it right now in one hit and get any stimulatory effect out there as soon as possible?
Andrew, agreed. Treasury did the same thing, but worse, in the early 90s. At least this time they stopped before the retail sector crashed.
dd @ 16 – RBA is playing balancing game between keeping the powder dry for the future, avoidng the liquidity trap discussed above, not spooking the horses by over-reacting, not letting the inflation genie out, avoiding wild swings in the AUD, etc etc.
The key however is market expectations. Despite what the majority of posters here would liketo think, the market is king. If the RBA strays too far from what the market expects then the unintended consequences can be severe. That said, acting outside of market expectations is also the best way to achieve some desired outcomes, occaisonally.
There is no “cookie-cutter” solution.
On the banks, you need to watch what they do, not what they say. And what they’re doing (including not passing on big interest rate cuts) says they’re hurting more than they’re letting on. That’s an observation strengthened by the the government’s firm support for what they’re doing and saying (you don’t need to loudly tell everybody that our banks are better off than other banks if in fact they are).
I reckon getting a new loan out of them in the next year will be tough.
You do if you want to reduce the impact of an unnecessary run on the bank.
I don’t think their policies were dumb at all. In a time where credit was being recklessly handed out to anyone and everyone, they moved to reduce this flow and limit the damage it was going to cause the Australian economy. Can you imagine how much higher housing prices would be, and how much bigger the bubble to burst, if interest rates had stayed as low as they are going to be?
dd @ 16 – I suspect they’re worried that if they suddenly drop rates by say 3% people will panic that things must be really really bad, rather than be encouraged to spend with lower interest rates.
dd @ 19 – reports are that some of banks are no longer offering products like zero deposit loans. IMO a good thing, but its a sign they are removing the riskier products they offer.
Fozzy @ 15 – that may be true, but it would also mean making the banks take higher risks than they otherwise would, increasing the chances that one of them would fall over. In the case of the CBA if it was fully government owned that would mean the tax payers would be up to cover all the losses like has happened in the past with failed government owned state banks. Probably would happen to a certain extent with private banks too with deposit guarantees.