“Saving” Only Comes After Mortgage Repayment Increase

Before I get on to today’s Money Morning, we’ve received some feedback from yesterday’s article. The complaint has been that we didn’t compare apples with apples.

That it’s not fair to compare the return of a leveraged investment property with an unleveraged dividend paying stock.

Of course that’s nonsense. Of course it’s fair. As we pointed out in yesterday’s article, the over-riding sales pitch for property investors is the benefit of negative gearing. That you should borrow as much as you can in order to be able to get the biggest tax advantage.

The property spruikers can’t have it both ways. When was the last time you heard a property spruiker tell you that you should only ever pay cash for a property? Hmm, thought so!

Anyway, on to today…

At roughly the same time as you receive today’s Money Morning, the Australian Bureau of Statistics (ABS) will release the latest quarterly consumer price index (CPI) figure.

You can almost guarantee that whatever the outcome, the mainstream commentators and economists will paint it as positive news for the Australian economy.

If the CPI is lower than expected then that’ll be good news as it ‘proves’ that stimulus spending hasn’t ignited inflation. And if it’s higher than expected it will ‘prove’ how resilient the Australian economy and consumers have been.

Then there will be the follow-on analysis as to what this means to the Reserve Bank of Australia’s (RBA) interest rate decision next week.

But if the analysis of the “top macroeconomist” from Access Economics, Chris Richardson is anything to go by, prepare to be bamboozled and baffled.

In a wonderful piece of illogical thought, according to today’s News Ltd article, families will be able to make savings on their mortgage repayments this year thanks to rising interest rates.

Has some clever way of fiddling the books that would be worthy of a “Cut your mortgage in half” story on Today Tonight been discovered?

Erm, not quite.

Money Morning reader Adrian brought our attention to the story from News Ltd this morning:

“Mortgage respite in sight for homeowners”

At first glance you could be forgiven for thinking Mr. Richardson is predicting that interest rates will fall, or at the very least remain unchanged this year.

But look, we’ll give him the benefit of the doubt. Either he’s one of Australia’s most inept economists or John Rolfe at The Daily Telegraph is one of Australia’s most inept journalists.

Or maybe it’s both, who knows.

According to the article, “Futures markets predict the Reserve [RBA] will raise official interest rates by 1 per cent this year, beginning with a 25 basis point increase in February or March.”

We won’t argue with that statement, the Futures markets are indicating that as a strong possibility.

But have no fear, because this is where the “savings” come in.

Despite the prediction that the RBA will increase rates by 1%, Mr. Richardson believes the banks will only pass on 0.7% of the increase to borrowers.

Should they do so then “homeowners repaying a $300,000 mortgage would save more than $60 a month.”

Of course the “saving” only comes after they’ve seen their mortgage repayment increase by over $120 a month. But as the paper points out, “That would be great news for new homeowners such as Strathmore Meurer and Sarah Emms. The St George customers, who bought a Petersham house, have already been hit by repayment increases of $300 a month.”

Oops! So ‘lucky’ Strathmore and Sarah can look forward to possibly an extra $120 a month on top of the $300 increase by the end of this year. And that’s providing Mr. Richardson is right and the banks don’t follow the RBAs rate increases.

But at least it may not be an extra $180 a month. The $60 difference is the saving apparently.

But wait, the “savings” are expected to continue into 2011 as Mr. Richardson claims, “We are probably looking at 30 basis points in 2010 and another 30 or 40 points in 2011.”

So if we take the current outlook from the Futures market on the direction of interest rates, it’s building in the likelihood of rates reaching 5.1% by June 2011:

So giving Richardson another benefit of the doubt he’s predicting that borrowers will only be burdened by an interest rate rise of 0.75% over the next eighteen months…

The rest will be savings!

We’ll believe that when we see it.

Look, we’ve no idea where interest rates will end up. All we do know is that it will be higher than 3.75%. But the mistake the mainstream is making is the idea that RBA interest rates at 5% is the ‘normal’ level for interest rates.

That by increasing the cash rate to that level is just returning them to a neutral point in the interest rate cycle.

Unfortunately, as the example of Strathmore and Sarah shows, that’s not true. “Normal” for them was when the cash rate was 3%. Just as “normal” was 7.25% for new borrowers in March 2008.

When interest rates move back to 5% and the mortgage rate increases to 8% or 9%, it will be very abnormal for those that have borrowed at all-time low rates.

In fact, you can guarantee those borrowers won’t be cheering the “savings” they’re making just because the mortgage rate is at 9% instead of 9.5%. Far from it.

But it’s the whole idea that an increased cost is being repackaged by the mainstream media as a saving. Of course, it’s not that different from the shopping bargain hunter who’s ecstatic at getting something for half price even though they’ve bought something they wouldn’t normally have purchased.

There’s no saving at all, just an increased cost.

Today’s CPI number will likely produce a similar reaction. A lower figure than expected will have the commentators all of a lather that the inflation genie hasn’t been let out of the bottle, ignoring the fact that the cost of living has still risen.

Whereas a higher than expected number will get the cheerleaders excited about the prospect of a further interest rate rise and all the lovely “savings” borrowers can make in the coming months.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

On Monday, the S&P/ASX 200 was down 70 points in the first 15 minutes of trading. After the initial drop, the index closed the day down by only 32 points to 4,717.90.

The Australian Bureau of Statistics will release the Consumer Price Index (CPI) for December. These figures are the last set of figures the RBA is waiting on for when they meet next Tuesday.

The Dow Jones Industrial Average was down on Tuesday, closing at 10,194.29, lower by only 2 points.

The Fed’s two day Open Market Committee began yesterday, however many are expecting rates to remain unchanged as Ben Bernanke is yet to be confirmed as chairman for a second term. Read more here.

In the UK, the FTSE was up by 16 points, ending the day at 5,276.85. Surprisingly, it was the Pharmaceutical companies that pushed the Footsie higher, with most averaging a again of 1.5% for the trading session.

The Nikkei was down by 1.78%, closing at 10,325.28.

The price of spot gold in Australian dollars is trading at $1,222.37 while in US Dollars it is trading at $1,098.18. The price of silver in Aussie dollars is $18.68 and in US Dollars it is $16.78.

The Aussie dollar versus the US dollar is trading at USD$0.8985, and against the Japanese Yen JPY80.57.

Crude Oil closed at USD$74.71

For the biggest movers on the market yesterday click here…

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Tagged as: Access Economics, Australian Bureau of Statistics, consumer price index, leveraged investment property, mortgage repayment, reserve bank of australia, saving