Why the RBA shouldn’t reward property investors with a 0.50% rate cut

australian home with banknotes

It’s been yet another week of outstanding home sales in Sydney and Melbourne. The auction clearance rates in the two thriving cities raised sales to their third highest weekend ever.

Nine out 10 homes in Sydney auctioned off over the weekend were sold. That’s a staggering amount. Combined, the major capital cities sold 79% of all properties that went under the hammer. This is the highest figure since September 2009.

That should give you some cause for concern. If you’re a property investor, you might be  wondering what all the fuss is about. A buoyant housing market is a good thing, right? I won’t disagree with you there. Owning property is a good business to be in right now.

But it isn’t a good thing when you have to balance a housing boom with a sluggish economy. And that’s what the RBA will have to consider when they meet to decide on interest rates  tomorrow.

Last week the RBA Rate Indicator suggested a 71% probability that rates would be cut this month. More cautious economists predict a 0.25% reduction. Others have been bold enough to predict a 0.50% slash in rates. That would lower the cash rate to 1.75%. It would put the Aussie economy in uncharted territory. But it would also be following the trend among major developed economies.

The world’s been playing a zero-sum game by lowering rates to boost competitiveness and keep currencies undervalued. This kind of financial doping has been going on for years, and it only looks to be accelerating.

Why some economists are predicting a 0.50% rate cut

Here at The Daily Reckoning, we don’t always agree on what the RBA will do with rates. Our editor in chief Kris Sayce wrote last week predicting that the RBA could cut rates by 50 basis points.

Kris focused on what the market needs. He says that anything less than a 0.50% reduction would send the wrong signals to the market. All he means by this is that a 0.25% reduction wouldn’t be enough to jolt the economy.

He knows that cutting rates is vital to preventing the economy from deteriorating further. And he reckons the RBA would rather stoke the housing market than sit idly by and let the economy flounder.

He also rightly points out that if the RBA doesn’t cut interest rates, the Aussie dollar would strengthen against the US dollar. The only way this would be acceptable is if the US Federal Reserve Bank raised interest rates. That would give the RBA some breathing room to keep rates on hold. But that’s not going to happen anytime soon. The Americans have their own economy to worry about.

Normally, I’d agree with Kris. But I believe it’s become impossible to ignore the property boom any longer. Even if it sends out a lukewarm signal to markets, a 0.25% cut in the interest rate is the only sensible thing to do.

An RBA decision to reduce the rate by 50 basis points a week before a budget is due is irresponsible. We know that the government will find ways to reduce spending. There’s a $40 billion budget deficit to think of. They’ve been hinting at this for months now. And they’ve also been hard at work scheming up new ways to tax everyone to make up for it.

But if they knew that rates would be cut by 0.50%, they’d have the greenlight to propose a softer budget. And I don’t think they’re prepared for that. I believe the RBA will let the market respond to the government’s budget before making another decision next month.

The government has one more budget to deliver next year before the federal elections are due. That’s the one they’ll place all their focus on. The budget on May 12, on the other hand, will be tough. But I believe the RBA will give the market a month to digest the government’s budget.

Property investors will still benefit from any downward change — a 0.25% cut is still a cut. So don’t expect that your property investments will suffer anytime soon. And with housing booming, you can expect a substantial amount of that the new money in the system to go towards real estate.

But it’s important the RBA acts responsibly tomorrow. Cutting rates by 0.50% will only raise fears that the economy is setting itself up for a spectacular crash in the future.

Mat Spasic,

Contributor, The Daily Reckoning

PS: The Daily Reckoning’s Phillip J Anderson has been writing about Australia’s impending property boom for years. So far he’s been right on the money. Prices keep going up with no end in sight. In his free report, ‘Why Australian Property Is On The Verge Of A Decade Long Boom’,  Phil shows you how to navigate your investment portfolio over the next 10 years. To find out how to download the report, click here.

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The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.

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