If you asked the RBA what they are aiming to do with yesterday’s interest rate cut you’d get a vague answer that they are only responding to the economy, not directing it. In a sense that’s true. The RBA does not force anyone to borrow money. But in reality, the rest of us see the RBA not as some uncaring and unconcerned data-driven machine but as a money tree, which is sometimes in full bloom and sometimes denuded of foliage. Thus when interest rates are high we tend to bunker down and wait for Spring. When they are low we enter a frenzied harvest and store the debt in the nearest house.
The question of who is responsible in this economic paradigm is about to become central to the future of the Australian economy.
As it cut interest rates yesterday towards record lows, the RBA said the following:
Investment in dwellings has remained subdued, though there have been some tentative signs of improvement, while non-residential building investment has also remained weak. Looking ahead, 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.
For a central bank that sees itself as the ghost in the machine, this is a pretty plain statement of intent vis-a-vis the housing market. They want to see investment in housing rise. So, for the rest of us, and our children, the question must be asked what precisely is being intended here?
The RBA has spent the better part of two years telling us that we are lucky to have the mining boom. It has described this as a “glass half-full” situation in which it has been necessary to have high interest rates so that we don’t all go grabbing for the money tree at once. But, it has argued, the upside is that we’ve been able to dodge the problems plaguing other Western nations of having to reduce our household debt levels, even if it is no longer wise to expand them further.
So, if the RBA is now declaring it wants to see an acceleration in housing investment, and is in full bloom vis-a-vis the cheap money to make it happen, can we rightly conclude that it’s time to reach for the machete, chain saw or combine harvester and load up on debt?
I don’t think so. In fact, the RBA’s message means something else entirely in my view. What the RBA wants to see is a rise in new home construction not established dwelling investment.
Consider, the high interest rates of the mining boom have hit two sectors harder than any other in terms of employment. Those sectors are property construction and retail. This was not coincidence. The RBA needed to see construction workers shift from building houses to building mines and raising interest rates to make it happen came with the added bonus of reducing housing construction during a time when prices were going to be under pressure anyway. Reducing supply made sense on both counts. Retail was always going to have to correct following its post-millennium debt-fuelled boom.
But now, as the mining boom approaches a peak that is much lower and sooner than anyone expected (except MB!) the RBA is intending to return many of those same construction workers and families to rebounding jobs in housing construction. It is also intending to free up extra spending money for households carrying large debt burdens and at least keep retail moving.
In short, the RBA’s intent is to boost or support demand in these sectors, as well as those that have been hurt by a high dollar.
So, does that mean it wants to re-inflate the housing market? Again, I would argue that it does not. Perhaps the worst kept secret in global markets is that overvalued Australian house prices are an economic vulnerability. The IMF has said it. The World Bank has said it. The major ratings agencies have said it. Countless warnings have been uttered. Just last week the RBA itself reiterated that:
“With demand for credit likely to remain moderate, a challenge for firms in a competitive banking environment will be to resist the pressure to ease lending standards to gain market share in the pursuit of unrealistic profit expectations…it would be undesirable if banks responded [to low credit growth] by loosening their lending standards.”
There is also the probability that a resumption of growth in house prices is simply not possible. The post-millennium housing boom was driven above all by one factor. It was funded by offshore borrowing in the banking system. That borrowing was the source for the GFC government guarantees of the banking system and has since been the focus of all of the countless warnings about Australian vulnerability mentioned above. NAB recently stated publicly that it did not think it possible for the banks to increase their borrowing offshore any more. Not only in percentage terms but the absolute levels as well.
There are, of course, local deposits to fund credit expansion. But the high savings of Australian households of the past few years are also about to come under pressure. The end of the mining boom, as well as the cut backs we are seeing in state and federal government budgets will reduce income growth. So, where are the banks going to find the money to raise lending levels?
The RBA knows all of this. Its rate cuts are not aimed at firing up another round of housing speculation. They are aimed at boosting borrowing enough to keep house prices stable, perhaps rising slightly, just enough that new homes remain attractive to prospective buyers.
Whether they succeed of course is up to you.