Why the RBA Won’t Raise Interest Rates

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The Reserve Bank of Australia meets today to decide on interest rates, and some commentators are calling for an immediate rate cut, reasoning that the next chance to do something will not be until February next year (the RBA doesn’t meet in January).

What — do they think the RBA is the Fed or something? That is, as soon as the market crashes by a few percent, it’s time to open up the liquidity spigots and reassure the speculators?

Thankfully, the RBA aren’t that stupid. At least I don’t think they are. We’ll know by 2pm this afternoon, but I’m tipping they keep rates on hold.

There is one strong hint though that the next move in interest rates will be down, not up. The afr.com explains why:

Bets are mounting that weakness in both Australia and the global economy could force the Reserve Bank of Australia to cut rates within 12 months, despite an almost-consensus view among bank-based economists that the RBA’s next move is up.

Hang on…Australia is in the middle of one of its greatest terms of trade crashes ever and nearly every single bank economist thinks rates will be higher next year? What are they teaching these people at uni, seriously?

Here’s a tip, people. It is very unlikely that the RBA would ever raise rates into a crashing terms of trade. It just wouldn’t make sense. You don’t need an economics degree to know that…only a modicum of common sense.

A falling terms of trade reduces national income. This means that, at an aggregate level, disposable incomes are falling.

Do they really think the RBA is going to add to that reduction in disposable incomes by raising rates? Of course not. Why did rates fall by so much from 2011 to 2013? It was because of the first leg down in the terms of trade.

The nasty side-effect of this interest rate cutting cycle was a booming housing market…mostly centred around Sydney and Melbourne. On the plus side, it did increase dwelling approvals to a cyclical high (meaning more supply will come into the market in the years ahead), but the house price speculation that came with it could prove destabilising for the economy if it continues to get out of hand.

Another round of interest rate cuts could well do that. So my guess is that the RBA won’t move on interest rates until there is some movement on the ‘macroprudential’ front. This refers to changes to rules or regulations that could curb investor speculation, or make banks hold more capital against certain types of loans.

And don’t forget the Murray Report is currently in the hands of the government. This is likely to recommend changes to the financial system that will at least stem the flow of credit to the housing sector.

Speaking of house prices, you’re seeing increasing signs that price gains are beginning to cool. Yesterday, RP Data reported that for the month of November average capital city prices fell 0.3%. On a year-on-year basis, they’re still up 8.5%, but the rate of growth is slowing.

More importantly, the returns are nearly all coming from Sydney (up 13.2% yoy) and Melbourne (up 8.3% yoy). Bad luck for the rest of Australia. I’m not sure how that wealth effect theory is going to play out.

Which is a bit of a worry for the RBA. The whole rate cutting rationale was to create a housing boom (as in construction and consumption) to offset the faltering mining boom. As we head into 2015, that doesn’t look like it’ll happen. Construction activity looks to have peaked, and consumers aren’t exactly champing at the bit, are they?

That’s what happens when you base an economy around a flawed investment idea (China will soak up our commodities at high prices forever) and leverage that short term income gain on property speculation.

It leaves you desperate for lower and lower interest rates when growth slows — because in a structurally weak economy, there’s no real other answer. The government could get serious about reform, but that’s too hard. Better to kick the can down the road and hope ‘something will turn up’.

Tony Abbot did just that yesterday by saying that iron ore prices would pick up soon. It’s all very Micawberish.

Ironically, something did turn up for Dickens’s famous character…he emigrated to Australia and got a respectable job!

Greg Canavan+
For The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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2 Comments on "Why the RBA Won’t Raise Interest Rates"

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slewie the pi-rat
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“The central bank has kept the cash rate unchanged at 2.5 per cent.” [Yahoo] a lot depends on centralized decision-making and “national” policy. and then it has to come in different sizes and colors, too–a technocratic coat of many colors, which never seems to fit quite right and causes a frequent rash. as a planet, in the “global village”, all the fiat players seem to be involved in the same game, at least on the surface. things aren’t going great, right now, and, although politically, people may get impatient because they have reified [made a “concrete” noun out of] a… Read more »
Mark Tomarket
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Won’t raise rates? So said the Russians before their dollar tanked. Look what they have now – official inflation of 8%, real world inflation of between 18 and 80% and a cash rate of 10%. We keep talking as though we will have a choice here. We didn’t in the late 80s/early 90s and we sure as hell won’t this time either.

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