Shane Oliver is out echoing the thoughts of MB today, calling rates to 2.5%. He reckons:
- The need to boost the non-mining sectors of the economy as the mining boom fades at a time when the $A remains strong and fiscal cutbacks are intensifying means the RBA will have to cut interest rates further.
- Post GFC caution has likely resulted in a reduction in the neutral level for bank lending rates, such that they are only just now starting to become stimulatory.
- Our assessment remains that standard variable mortgage rates will need to fall to around 6%, which implies that the official cash rate will need to fall to 2.5%.
- We expect this to occur over the next six months, with the RBA cutting again next month by another 0.25%.
- Bank deposit rates will fall further, but the Australian share market is likely to be a key beneficiary as lower interest rates eventually boost housing activity & retailing.
Now, I agree on rates. But not on the dollar. By the time rates get two more cuts, markets are going to realise that the risk/reward scenario for holding Australian government bonds, or other bonds for that matter, has swung decidedly against them. This is because the rush into these bonds is driven, in part, by the knowledge that Australia is not a perfect economy. What I mean is, at the moment, because the Australian economy is fundamentally weak, folks buying our bonds know that interest rates are going to fall. Thus, there is a capital gain to be made on bonds as the already paltry yields fall.
Once you get to 2.75ish% you are really approaching an Australian version of ZIRP. So, if you are holding an Australian government bond, your capital gain upside is capped and you’re left with an asset with a near negative yield in real terms and a whole lot of currency risk. The answer is very clearly to exit before everyone else does.
So, Oliver is wrong on the dollar in my view. If rates fall as far he says, the dollar is going to ninety cents and below, still prevented from finding its real value further down by the hapless central banks.
On the rest I kind of agree, although the risks are to the downside. If housing can be fired up sooner or later, it can only be let run briefly or mildly, ideally flat in real terms. That is our best case.
Anything else and deposit rates fall, banks seek to expand offshore borrowing and ratings agencies pounce.
