Will the RBA cut?

Right now, the economy is far weaker than media and bank economist blather is letting on, or understands. For that matter it’s far more weak than global markets are assuming.

The reason is simple and goes back to a piece I wrote ten weeks ago:

So, let’s take a closer look at where we are now. The below image is the same year on year credit growth rates graphed monthly but this time only since 2005:

Here we have a clear picture of the new normal for Australian business and assets. In terms of business, there is clear deleveraging. Let’s not forget that this is largely bank debt (with some securitisation thrown in) and does not include equity nor bond markets accessed offshore. Nonetheless, it shows a clear unwillingness to either lend or borrow at historic rates of growth.

One doesn’t want to jump to too many conclusions from such broad data, but we may find at least part of the answer for why in the personal debt trend. If we take this as a proxy for demand and the aspiration to consumption then it ain’t looking too good. And why would business take on debt to expand when demand is so insipid?

The truth is that this is what the RBA wants to see. They have engineered interest rates to produce just this result. Australia’s new normal is that it can no longer rely on the accumulation of offshore debt to boost asset prices and consumption. The GFC proved that international markets can and will shut down. To persist with a large external imbalance is imprudent.

In short, despite there being to date no bust in housing, Australia’s economy is in a post-bubble adjustment.

Normally, such adjustments are achieved through a long a painful process of deleveraging and growth out of the debt through increased competitiveness, generally via a falling currency (or, in Europe’s case, general deflation).

To date, Australia has rather been able to outgrow its bubble because of the income flows and business investment emanating from the iron ore and coal booms:

To describe this as lucky hardly seems to credit it.

Where the rubber really hits the road for the RBA, however, is in mortgages. The great experiment, of outgrowing a huge bubble without having to deleverage, hinges ultimately on the housing market.

There is never a stasis point for capital-growth asset markets. Or so they say. Such markets are either going up, as more people borrow ever more amounts, or they are going down as fewer people do so and price falls beget selling on capital loss capitulation.

The recent history of the aggregates appears to test this thesis.

We know that the current pace of mortgage expansion is insufficient to keep house prices growing. Indeed prices are falling in general, if only slowly at this point. The question is, what happens next?

Counter intuitively, this blogger has been of the view that a plateau in property prices is possible, for the reason that the bubble psychology in Australia is so entrenched that, supported by strong employment from the commodities boom, investors will look through weakness in the mistaken belief that they will make later gains.

There is evidence here that to date this is happening. In 34 years, mortgage credit growth only briefly dipped beneath 10% in the eighties. Yet it has now sat below that level for nearly three years without collapsing. Let’s call this disleveraging.

There is also evidence at the macro level that this disleveraging is working. At the conclusion of the 06/07 financial year Australia’s debt to GDP ratio was 164%. The next near it was 171%. The last two years it has shrunk first to 160% in June 08/09 and at the end of last financial year was 153%. You might choose a different data mix but the trend is clear.

Yet, the longer the RBA engineers these credit growth rates, the more likely the era of across-the-board property price rises is over.

An optimist would say that there will be local growth and falls, and those with the expertise to find the right one could benefit. Which is as it should be, is it not?

A realist, however, would say that there is no stasis in asset markets driven by capital growth. Either  credit growth and prices resume climbing or they keep falling.

A pessimist would say that these rates are unsustainable now.

For the time being, this blogger is still an optimist. On one condition. There is so little momentum in these disleveraging aggregates that the economy looks vulnerable to a shock  – an oil spike or China grabbing the handbrake or the RBA overdoing it – and disleveraging will become deleveraging, with a vengeance.

So has the RBA overdone it? In combination with oil and floods, yes, it has in the short term.

The RBA has been intensely focussed on the medium term benefits of the commodities boom and the rising income that goes with it. But right now, although the boom is flowing through mining company profits, the expected investment surge is yet to materialise.

Sure, there’s plenty of capex intention in the ABS survey, but non-residential building approvals right now are stagnant at best:

NO sign yet of a mining construction boom here.

Moreover, consumers confidence is weak. And there is NO sign that the new wave of higher savings and lower consumption is anything other than a structural shift. Courtesy of an unwitting Adam Carr:

Look at that whopping great trend change that I’ve marked in green. The new trend is now three years old and entrenched.

Moreover, with oil riding high, there is no prospect of any of this changing, at least according to history:

On top of all of this, we also now have the lacklustre February credit aggregates and terrible mortgage data from yesterday.

I’ve no doubt that we can expect strong growth in actual mining investment later in the year on the back of the terms of trade and the RBA is rightly focussed on this medium term prospect. It’s probably still right to think that monetary policy operates with a lag too so they will not be in a hurry to change direction.

Moreover, their rhetoric has been very firm on the need to maintain a tightening bias and has been reinforced by government blather about the need for a tough Budget. This represents something of a political corner in which to be painted. Although, thankfully, one of Glenn Stevens great attributes is his fierce independence. Nonetheless, a change of direction would involve a fair slice of humble pie.

They can always blame the shocks for unexpected weakness.

But will they move? If this were 2005, it would be a lay down mazaire. But now, post-GFC, I don’t think so. The medium term still has the RBA by the scruff of the neck. And rightly, they will be very concerned that the Australian housing bubble psychology will re-emerge at the first sign of cheaper dough. The VERY LAST thing they (and I) want to see  is the punters off to the races again on property.

As Delusional Economics points out this morning, there are already signs of a bounce in March mortgage data on bank teaser loans. And the RBA will want to see more evidence that housing weakness isn’t shock related.

The bank already softened its rhetoric at the Tuesday meeting on shock sympathies and pushed bank economist perceptions of rate rises out to the end of 2011. We are, in effect, already on hold.

Whether that will be enough to stabilise mortgages, only time will tell. I’m beginning to sorely doubt it.

David Llewellyn-Smith
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  1. I made this comment a couple of months ago that I believe it will be like in 2008 where the RBA lowers rates. Then they will say they were to aggressive. I got to say though this time they needed the rise in November. Australians, Banks, businesses etc have over spent/consumed. It was looking like they might continue.

  2. Chris Joye (and James McIntyre of the CBA) say its all about the weather and natural disaters…

    Given the uncertainties, it is too early to suggest that a downtrend is underway in the housing market. A recovery in housing finance approvals was evident running into the end of 2010. Two months of disaster, or weather, affected data have wiped out that momentum. The key for policy will be to ascertain whether the momentum returns.


    FWIW, I reckon the RBA has things exactly where they want it — stagnating in anticipation of the investment boom. They certainly won’t be changing anything until its obvious whether the recent downturn is a short term effect of natural disasters or an accelerating trend.

  3. I used my crystal ball to tell me after the Nov effective double rate rise, the next time will be a cut. Still waiting but every day, it inches closer.

  4. yes … but on the other hand the publicly stated position of managing inflation and the flow on effects of the floods etc has been to increase demand for the goods (not only food, but things like paint carpets etc)

  5. I’d be interested to hear from DFM and other currency/macro gurus about the currency markets reaction if the RBA cuts rates.

    Wouldn’t that take some wind out of the AUD’s sails?

    • I’m no guru but the Aussie would get slammed. If they cut, traders around the world will find out that the ‘Dutch Disease’ has fully taken hold of the Australian economy. Add the ECB, will probably raise soon, the Fed will have to raise as well to combat inflation.
      The only savior would be an extended shutdown of the US Govt and more Benji punchbowl in the form of QE3.

      Getting to the pointy end of this, I recon. The next 1/2 months are going to be a doosy.

  6. In my view, it would stun the market. And yes, the Aussie would get caned. Then rebound. Then sell-off again. Basically, it would elevate economic fundamentals to at least the level of trading fundamentals. And remind the world that we are mortal.

  7. One factor has, I believe, been greatly overlooked as a cause of the recent structural change in spending/saving habits of Australians: demographics. It is well known that old people are, in general, savers while younger people are spenders. Perhaps the baby boomer generation, now entering retirement, are starting to become serious savers with a view to passing on a legacy to their children. We have seen this phenomenon on a much larger scale in Japan, which is ahead of us on the demographic curve. Consumer demand there has been moribund for twenty years.

    • That is alleviated if the retirement age is raised to 70 and the preservation age raised to 65.

      More emoney can be saved for retirement, no more entrants added the the pool of government funded retirees for 5 years, and people will spend 5 less drawing down retirement funds from government coffers.

      Also this group will be consuming more for 5 years, adding to aggregate demand at a higher level than they would as aged pensioners.

      • Alex Heyworth

        If that was addressed to me, I’d never heard of him until you mentioned the name.

        • Torchwood1979

          Yes, sure was. And if demographics and their impact on consumption interest you then I highly recommend his work.

  8. IMO any further rise in interest rate or even contemplation of one would not bode well fore either consumers or export industries. RBA is just overemphasizing the impact of income boost of commodity prices.
    Consumers and retail are too big a slice of pie on a relative basis to be allowed to expended at cost of further investment expectations.

    If heaven forbid QE3 doesn’t eventuate, that will be one spectacular scenario of seeing how monthly contract pricing works in reverse.

    Hat tip to Cameron Murray who was arguing this case 7 months ago when everything was hunky dory!