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Why the RBA will cut rates in 2019
I love the smell of a housing credit crunch in the morning.
House prices are falling in two of the biggest cities in Australia.
APRA is cracking the whip.
No longer can banks lend to anything with bricks and a heartbeat.
Bank CEOs are begging forgiveness for their misdeeds.
The newspapers are spreading fear (Stop it. That’s our job!) that a credit crunch is coming.
And all of this is setting up the Reserve Bank of Australia for a rate cut.
Bankers cry crocodile tears
We’ve seen the odd apology from bank CEOs this month for their ‘misconduct’.
Although, it’s hard to take these seriously when they come from people sitting in their Vaucluse and Toorak mansions.
To think the conclusion of the estimated $75 million Royal Banking Commission was that ‘bankers are greedy’.
It turns out, Aussie banks – most notably the big four – put profits before people.
Who’d have thunk it? A business, whose sole income comes from lending the most amount of money possible, put their bottom line ahead of a customer taking on bigger and bigger debts.
How’d they get away with it?
Well, consistently rising property prices were one way. Aside from a blip of a drop in house prices for a few months in 2008, there was the persistent analysis that property prices will always rise.
Because of this untruth, banks could get away with unfathomable lending criteria.
Banks assessed people for mortgages on a guestimate. A figure that turns out to be well below what their living expenses were. Salaries were ‘annualised’ for maximum borrowing potential.
In some cases, damn near fraudulent documents were provided for loan applications. Lenders simply looked the other way.
And now, we are left with the outcome of the Royal Banking Commission.
Already, the effects are being felt.
Major Aussie banks aren’t willing to lend as much. Some properties aren’t being refinanced as the debt is bigger than the value of the house.
Plus, we have the Australian Prudential Regulation Authority (APRA) stepping in. Placing caps on how much banks can lend to certain sections of the market.
With APRA and banks in the spotlight, the previous decade of willy-nilly lending is no longer an option.
At least, for now.
The immediate effects of this means there’s a lot less credit to go around right now.
This, of course, will impact house prices. That’s what happens when you prop up a section of the market with cheap loans.
We’ve seen falls of 5.2% and 7.8% in Melbourne and Sydney respectively this year. Granted, these two are the worst falls compared to elsewhere in the country.
More to the point, over the past week, I’ve read many columns that suggest house prices will fall for another two or three years into 2021.
The reason? That conservative bank lending will drag out a property price slump.
But there’s a big problem with that analysis.
Because a restriction of credit and falling houses will crash the Aussie economy.
And we know the Reserve Bank of Australia won’t allow that.
From David Jones to Kmart
Economists like to call it the ‘wealth effect’.
The idea is when you feel wealthy, you are more likely to spend money.
And for Australians, if house prices are rising, people feel like they can spend more money on things.
In the short-term, it shows up in discretionary retail statistics.
Things like spending money on apparel, sporting goods and dining out, for example.
Over the longer term, however, the ‘wealth effect’ appears in the purchase of new cars, caravans and boats to name a few.
The flip side to this is that if people feel short of a dollar, they rein in spending.
Which could have a devastating impact for Australia.
More than 55% of our gross domestic product comes from consumption. That is, the buying and selling of things in the economy.
Here’s the thing, though.
The wealth effect doesn’t necessarily mean wages are rising. It means that because asset values are growing, people are more likely to spend more.
When wages aren’t rising, people would normally increase their debt to fund these new purchases.
So, when house prices are falling in Australia, people aren’t willing to take on as much debt – if any at all – to buy these luxury items.
The overall result is a national drop in spending.
Which, in turn, feeds into a drop in consumption.
And if consumption drops, so does Australia’s gross domestic income.
Get ready for the credit boom
Since the Reserve Bank of Australia cut rates to 1.50% in August 2016, most commentary says the next move in rates will be ‘up’.
Citing the usual reasons, like the economic data, is positive. Then they claim any rate cut would only drive Aussie property prices higher.
They wouldn’t dare do that, seems to be the collective consensus.
Yet, the RBA spent five years cutting interest rates with a complete lack of regard as to what was going on with property prices.
The cheaper the rates got, the higher house prices went.
The point is, the RBA knew exactly what they were doing.
And here’s the thing.
They did it once, and they’ll do it again.
Falling house prices in Australia – coupled with less credit for mortgages – means property price falls are going to get bigger.
And the central bank isn’t going to sit idly and watch the economy tumble. They’ll have to meddle.
For starters, the central bank is well aware they can’t raise rates.
A 0.25% rate increase from the RBA is estimated to have the equivalent impact of a 0.75% rate hike. Simply because our personal debt is so large.
Not only that, but Australian banks are raising rates. Doing the RBA’s work for them.
But the problem with that is the Aussie banks increasing rates is having a similar impact to if the RBA was.
Essentially, Aussie banks are raising the cost of living through higher mortgage rates. Which affects how people spend their money in the economy.
The higher bank mortgage rates are acting as a handbrake on consumption in Australia.
This is a double whammy for falling property prices and will contribute to falling gross domestic product.
All of which could sleepwalk Australia into a recession.
The Reserve Bank of Australia will cut rates in a desperate attempt to avoid one.
And the rampant credit lending cycle will begin all over again.
Until next time,