RBA and Returning Interest Rates to “Normal” Levels

You can read the official press release from yesterday’s Reserve Bank of Australia (RBA) board meeting here.

In a couple of weeks the RBA will release the full minutes of the meeting. If the official version is anything like the previous versions it will mention international economic conditions, domestic economic conditions, financial markets, and considerations for monetary policy… Blah, blah, blah.

Of course the unofficial version goes something like this: [pump, pump, pump...]

For all the bluff and bluster about wanting to return interest rates to “normal” levels, there’s absolutely no doubt that the RBA lost its bottle.

It knows the impact that higher interest rates will have on the economy and so chose to take the cowards’ way out. The decision means the era of cheap money and easy credit continues. And that crazy housing bubble will last a while longer yet.

But yesterday’s decision by the RBA really shouldn’t come as any surprise. After all, as we pointed out in Money Morning on December 4 following Westpac’s interest rate increase of 0.45%:

“So, come next February and the next interest rate decision will the bank increase rates again because that’s what they planned to do anyway. Or will it cut them to take into account that Westpac has increased them too much? Or will it just leave the rate as it is?”

The fact is, last December Westpac played the RBA like a violin. In the same article we went on:

“All Westpac was doing was betting on the RBA continuing to increase rates through the early part of next year. Quite clearly, it’s [sic] thinking was, if the RBA is going to put rates up and harm all the lovely lending banks do, why not get in first and at least try and make some money out of it.

“That’s what they did. Their first gamble was that the other banks would follow. Their second gamble was that the RBA might think again about increasing rates at the February meeting, seeing as the banks were increasing rates anyway.”

And that’s exactly what happened. The poor little power-freaks on the RBA board who think they can tweak financial markets at their whim received a lesson from the bankers at Westpac.

As the RBA admitted in its statement:

“Lenders have generally raised rates a little more than the cash rate over recent months and most loan rates have risen by close to a percentage point.”

And not only that, but the bankers have backed the RBA into a corner so tight it’s in danger of crushing Governor Glen Stevens’ wooden head.

A new moral hazard

Just as the bank bail outs gave the banks carte blanche to take as many risks as they like – moral hazard, knowing full well the government will save their bacon, so the RBAs move yesterday has let the banks know that if they act independently of the RBA by increasing rates then the RBA won’t do anything.

That means bigger margins for the banks, higher interest costs for you, and a lame duck reserve bank. Not that that will stop it from fiddling with what it shouldn’t.

But let’s be honest, what is the point of the RBA? As we’ve mentioned before, it’s failed spectacularly in its main aim of providing a stable currency. Inflation of the money supply is proof of that. As our sometime contributor and ex-builder, Mark Thompson commented last year, it gets a “Grade F” on that score.

The general idea of having a group of half a dozen or so individuals invincibly setting interest rate levels is ridiculous. There’s nothing the RBA does that couldn’t be done better by the free market.

I mean, you don’t even have to look past the quarter-percentage point steps the RBA uses to raise or lower rates. Apart from it being a “tidy” number, what is the logical reason for moving rates by increments of 0.25%?

Why not 0.24% or 0.26%?

When you look at interest rate movements on the markets you don’t see them move in increments of a quarter point. Rates change on increments of 0.01%. Why does that happen? Because the free market demands it.

If futures markets traded in increments of 0.25% then few, if any traders would play along. In contrast, the RBA has no such market dynamic. It has a government mandated monopoly over interest rates and therefore can do how it pleases – it’s the same for all central banks.

Take a look at the table below of the ASX Target Rate Tracker:

The table shows the market expectation for an interest rate rise at the March RBA meeting.

Until yesterday, the financial markets had factored in a 100% chance of the RBA increasing rates by 0.25% in March. It was as dead a cert as you’ll ever see.

But then following yesterday’s RBA decision to not raise rates, suddenly markets don’t have a clue. Now the futures markets are only pricing in a 30% chance.

Last December we wrote that we’d like to give Westpac bankers a high-five for their ingenious decision to increase rates higher than the RBA move. We bet the other banks wish they’d followed Westpac’s lead and increased by the same amount.

Well today we’d like to give Glen ‘Woodenhead’ Stevens and his RBA buddies a slap across the chops for manipulating the markets.

Legalised market manipulation

And look, that’s exactly what it is. If any other private citizen or private firm intentionally manipulated financial markets for their own benefit as the RBA board members do, they’d be up before the beak quicker than you can say ‘monetary policy.’

That’s right, and I do mean for their own benefit. Maybe they don’t gain financially from it, but they gain mentally. It’s an ego thing. In their own mind they know the power they have to influence markets and they wield it with pride.

The fact is, holding rates at artificially low levels is doing irreparable long term damage to the economy. But it shouldn’t be left to a bunch of superannuated public servants and control freaks to determine the level of interest rates, it should be left to the free market.

Consider that table again. What is the market betting on? The truth is we don’t know. And the market doesn’t either.

The market is confused. Does it bet on an interest rate rise because market players believe an interest rate rise is necessary? Or does it bet on whether it thinks the RBA board thinks an interest rate rise is necessary?

And to take the manipulation further, the RBA board is trying to work out whether and how much the banks will adjust their interest rates before it decides whether to raise rates. So market players have to consider whether banks will independently raise rates in order to determine whether the RBA will raise rates…

Talk about a mess. It’s more like a standoff at the OK Corral than the functioning of a free market.

Think about it this way. For the past month individuals and businesses across the land have made decisions on their personal or business finances based on what they think will happen with interest rates.

The consensus among almost everyone was that interest rates would rise yesterday. So individuals and businesses may have acted accordingly. They may even have locked in a fixed interest rate in anticipation of it.

Or they may have bought Australian dollars and sold US dollars believing the rate would increase and the Aussie dollar would rise further or remain steady. Whatever individuals and businesses have done they’ve done so based on what they thought the market was telling them – that interest rates would rise.

Then what happens. The muggins’ on Martin Place decide to pull a fast one and not move rates. The outcome is that quite possibly hundreds of thousands of market players have been hoodwinked by the RBA.

But what would have happened in a free market? For a start, in a free market you wouldn’t get manipulation from government and government agencies.

Market players would make decisions free of manipulation by government. The market would send clear signals about which way interest rates were tending and people would act accordingly.

That very action would cause interest rates to move over time. The free market would eventually push interest rates to a level determined by free market forces.

Central banks create false signals

The problem with a manipulated market is that people see false signals. In hindsight people were fooled into believing the RBA would return interest rates to “normal” levels. And they were fooled into thinking that because it was the message coming from the RBA and all its mouthpieces in the mainstream press.

But then the RBA punched market players – that includes you by the way, individuals comprise the market as much as anyone else – in the guts by saying, “not so fast, we’ve changed our minds.”

Sure, in a free market individuals and businesses can change their minds and their priorities too. The difference is no one person or organisation would have the same level of control over the entire market.

No one person or organisation would be able to impact the personal or business decisions of millions of people through a single act.

Yet again, it’s the government’s banker that has decided who the winners and losers are rather than a genuinely free market. We can only hope the RBA is abolished before it gets the chance to celebrate its 60th birthday in nine years time…

Somehow and unfortunately, we can’t see that happening.

Cheers.
Kris.

RBA and Returning Interest Rates to "Normal" Levels, 7.9 out of 10 based on 16 ratings

Tagged as: cheap money, easy credit, Glenn Stevens, rba, reserve bank of australia, westpac