As you probably know, the Reserve Bank cut interest rates last week. The official rate is now 3.25%. It’s just 25 basis points away from the ‘emergency’ level of 3% reached in 2009.
There’s always a lot of hysteria around interest rate cut time. Much of the commentary is completely uninformed. So I want to ignore the noise and hype and tell you exactly what I think it all means.
The first point to note is that the RBA got it wrong. After spending 2012 being sanguine about China/the commodity boom and telling everyone that we’ve never had it so good, interest rates are now close to levels where we’ve never had it so bad.
With the recent plunge in bulk commodity prices, the RBA is now much more bearish on the outlook for the Aussie economy. It sees downside risks for the international economy. It’s now much more concerned about China than it was a few months ago. It got China badly wrong too.
How the RBA Got it Wrong
I suspect the RBA thought China would just opt for more stimulus efforts to offset its downturn — like every good Western central banker does — but that hasn’t transpired.
In ways they didn’t think possible, China is proving ‘different’ after all.
Here’s the relevant excerpt from its statement:
‘Growth in China has also slowed, and uncertainty about near term prospects is greater than it was some months ago. Around Asia generally, growth is being dampened by the more moderate Chinese expansion and the weakness in Europe.’
How uncertainty about China’s prospects is greater than it was a few months ago is a mystery to me. The RBA simply underestimated the China slowdown and the Chinese response to it. As a result, it now thinks that:
‘…the peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected. As this peak approaches it will be important that the forecast strengthening in some other components of demand starts to occur.’
In other words, we need to juice up other parts of the economy because the mining boom is just about over. On this basis, I expect more cuts to interest rates in the months ahead.
If you’ve been following the China bust story, none of this will really come as a surprise to you. But with all the media hype that comes with an interest rate cut, I do want to reiterate the story.
That is, interest rates are heading lower because the outlook is deteriorating. It’s because national income growth (as measured by gross domestic incomes) is non-existent.
This is due to the effects of a falling terms of trade. Along with weak credit growth, contracting national income means Australia is at risk of falling into recession in 2013.
The RBA (belatedly) recognises this. It’s trying to ramp up credit growth to offset the coming fall in national income. Recently released credit growth data for the month of August was very weak. In particular, housing credit growth is in the mire.
There will be a lot of talk about how lower interest rates will push house prices higher. For example, the Financial Review last week had an article that stated:
‘House prices, already rising at their fastest rate in more than two years, could gather more pace thanks to the Reserve Bank of Australia’s cut in interest rates.’
This commentary is straight from the spruikers handbook. Interest rates are falling because national income growth has stalled. To focus just on the interest rate cut, and not on the reason behind the cut, is low-grade analysis.
Watch Out for Real Estate in 2013
It’s the large and persistent rise in national incomes behind the historic bull market in house prices. National incomes surged nearly 6% in 2011 and nearly 4% in 2012. As that robust income growth flows through the economy (with a nearly 12 month lag) you’re seeing excitement in the property market again.
And with interest rate cuts again in the news, you’re going to see a lot of commentary about a resurgent housing market. Don’t fall for such shallow and self-serving analysis.
In my report for Sound Money Sound Investments last month I wrote:
‘…the big rebound in national income in 2011 (very strong at nearly 6%) is probably the reason behind the current tentative ‘recovery’ talk about residential property.’
The interest rate cut will just add fuel to the fire of this misguided analysis. As I said, don’t fall for it.
Getting back to the credit growth numbers and why they’re important…
Consider this. For the 12 months to August 2012, total housing credit growth (loans extended to owner-occupiers and investors) was just 4.8% — the lowest rate of growth since 1977, which is as far back as the RBA data goes.
In other words, in the 12 months to August, residential property loan growth was the lowest ever recorded!
So demand for credit is clearly not the reason behind the renewed (and apparent) increase in house prices.
I believe any tentative increase in prices (and that’s all it is) is entirely due to a big increase in national income (which was nearly 10% in the two years to June 2012, a huge rise).
The only problem is this income growth is about to go into reverse.
That being the case, you should take any burst of optimism over house prices with a large grain of salt. The reality of weaker or contracting income growth is in the pipeline NOW. It’s just a matter of time before it flows through the system.
The RBA knows it and wants to reignite credit growth from its current anaemic levels. With Australia’s mortgage debt-to-GDP ratio amongst the highest in the world, I’d be surprised if credit growth will fire back up again.
If I’m right, you’ll see the initial euphoria subside and bearish housing market headlines emerging again by early-to-mid 2013.
Greg Canavan
Editor, Sound Money. Sound Investments.
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