Election 2013: Day 2 (or, you could cut the interest rate with a knife)

Unfortunately tonight’s post will just be a short one, because I spent the day firstly finishing up my Drum post for tomorrow, and then the afternoon doing a live-blog for The Guardian on the interest rate decision.

So I’m pretty much brain fried.

The big news was the drop in interest rates, from 2.75% to 2.5%.

The politics is interesting because when you are a party that for nigh on 10 years has been banging away about how “interest rates will always be lower under a…” and you suddenly find that interest rates are now much lower than they were under your government, well you need to come up with a new line.

And so now it is “the economy will always be stronger under a Liberal Government”. This of course is patent bullshit for anyone old enough to remember life under the Fraser-Howard Government when both unemployment and inflation achieved the dubious achievement of being over 10% at the same time. We’ll also ignore that in March 2012 for the first time in over 40 years, GDP growth was over 3.5%, unemployment was under 5.5% and inflation was under 2.5%

Look if people want to indulge in pathetic “blah blah will always be blah blah under a blah Government” go ahead. But cripes, that doesn’t mean we have to swallow it.

So the interest rate cut dominated the day. It was the first time since the RBA has been independent that interest rates have been cut during an election campaign, and one of the great things about the cut is no one was suggesting it was a political cut.

But there was a lot of politics related to it.

Joe Hockey put forward his thesis that the RBA is only cutting rates because the economy is n bad shape. And look that’s fair enough – the RBA does cut rates when it needs to give the economy a shove. The key thing is to keep interest rate low when the economy is going strong. So in effect – looking at the average of rates “over the cycle”

 Hockey on AM this morning answered this way in response to the question of low rates under this government:

JOE HOCKEY: Well on average the interest rates have been lower under the Coalition, if you look at the Coalition electoral cycle, it was, the average standard variable mortgage rate was 7.26 per cent. Under Labor it's been 7.29 per cent. Small business, unsecured overdraft rate under us was 8.89 per cent, under Labor it's been 10.08 per cent.

Now c’mon, really Joe. You’re arguing that 7.26% to 7.29% is a wining argument? You do know that 0.03% is about a $5.80 difference per month in interest rate payments for a $300,00 loan?

That’s your big proof of better economic management?

Ok. I guess then you won’t mind if we take into account the fact that given all the banks are passing on the full rate cut, and that if we include this month, the average of mortgages under the ALP term of government will be 7.27%.

Will you still claim the $1.94 a month saving as proof the Libs know better how to run the economy?

How about if we include September (because any rate cut in September will occur before the election, so the ALP gets credit for that as well) and we suddenly find that the average under the ALP government since December 2007 is now 7.26%.

Hey look, take heart, a draw is still not a loss! (except of course if you’re playing the Ashes… cursed rain)

Maybe it’s time we put aside puerile “lowest interest rate” crud and focus on why interest rates might be low or high.

Hockey is right about the difference in rates for small business. But that has nothing to do with the ALP – unless Hockey thinks the ALP is to blame for the GFC (which, for all I know he does – it would make an improvement on most of his fellow LNP members who seem to have forgotten there was a GFC at all).

After the GFC, banks fled to safety. Risky loans were suddenly seen as too risky, and importantly risk carried with it a premium that it hadn’t had for any of the 2002-2007 years.

Small business loans are risky – at least riskier than a mortgage – and thus their rates have stayed relatively higher than have mortgage rates.

I’ve been noting this for a while with this graph:

Now Joe Hockey also in the press conference after the announcement sought to pooh pooh the cash rate by pointing out that the ALP’s low interest rate guff didn’t count because the spread (or gap) of the cash rate to the mortgage rate and business loan rates had grown since November 2007.

This is quite true, as indeed I have also noted many times before on this blog with this graph:

So it looks like case closed for Joe.

The problem is this is more a case of a little bit of knowledge being dangerous.

People might not borrow at the cash rate, but significantly the cash rate isn’t the only way banks borrow (or “raise) money.

If we look at the way bank raise funds we see that it changed rather drastically around the start of 2008 (exactly the same time that "spread in the above graph started going up).

And it wasn’t because of a Labor Government, it was because the raising of funds with the cheap “short term debt” from overseas suddenly started to get expensive.

Prior to the end of 2007 banks used to get about 30% of their funds  on the cheap from overseas (funds they used to then loan out to you and to businesses at a profit).

Now they get less than 20% of their funds this way.

Prior to 2008, domestic deposits (ie you and I and grandma putting our money either in a savings account or better still a “term deposit’”) had been declining in importance for banks. It was still the most important but it accounted for below 40% of all funds.

After the GFC, suddenly term deposits became like gold for banks – because they are safe – and when all the banks are after the same thing – you and I and grandma’s money – that means they need to pay more to get it (ie offer higher interest rates for deposits).

And thus not only did the importance of domestic deposits go up, so did the cost to the banks of such deposits.

So let’s look at the spread of the cash rate to term deposits:

Do you notice anything about the spread between 2003 and 2008?

Yep it was negative. The banks were giving you LESS interest for your deposits than they were paying with the cash rate! And this was for 40% of their funding! Talk about sweet deal!

See what happened when the GFC hit? Yep – boom. By 2010 the interest rate you could get for your term deposit was nearly 2.5 percentage points more than the cash rate.

Do you think that might have been a reason why banks suddenly weren’t able to pass on all the cuts in the cash rates?

And just to ram it home, let’s have a look at the cost of that overseas “short-term debt”. The best way is to look at the spread of the 3 month overnight index swaps to the 3 month bank bills. (That is basically nerdy, Banker-speak for the amount it cost banks to lend to each other over short period of time – the bigger the spread, the more it costs):

Again, notice how cheap and stable it all was from 2002 to 2007? Think the Howard Government had much to do with the rate banks were lending and borrowing from banks in American and Europe? Nope.

Now look at the situation while Labor have been in power. Calm is not the word. But GFC nuttiness is.

There is nothing the Govt can really do about this, but it explains why again the gap between the cash rate and your mortgage has increased. Banks went from being able to get around 30% of their funds at a nice cheap, stable rate, to suddenly it being a very scary and costly way to raise money.

And even though the rate is now back down, the RBA has a nice graph that shows how because of the average length of time such debt is held, it takes a while for the decrease in spread to flow through to the average cost of the banks’ funding.

Now I’ll leave you with one final graph.

It is a graph that looks at the spread between the average term deposit rate and the average mortgage rate.

In effect this is the difference between what the banks charge you to get money from them, and what they pay you to take your money.

If banks were screwing us, or if the ALP was useless at holding the banks to account and the Liberal Party could do much better, then you would think that the gap between the two would be quite s bit larger now than it was under Howard.

So what is the picture?

Well under the Howard Government – during period of amazing ease on the international banking market, where everyone thought cheap credit could last for ever – the average spread was 3.04. During the Rudd-Gillard Government, when the hangover of that lazy period of cheap credit sent shockwaves through the banking sector that were like 9.7 on the banking Richter scale, the average spread is 3.14.

At the moment though the spread is 2.9.

So I’ll give Hockey 0.1% point on average to brag about.

Slow hand clap.

But maybe, just maybe, it is time to stop comparing apples with apples. And maybe, just maybe it is time for those who would be our government to stop trying to tell us the lie that the GFC was just something that happened in the Northern Hemisphere and had no impact on Australia.

Anyhoo.

That’s my interest rate rant over.

***

While live-blogging today for three hours today, I very nearly went into head-explosion territory. It made me all the more respectful of the great work currently being done by those who live-blog daily politics.

Back in 2010 when I decided to do a daily post on the election I did so because nowhere was there a good close analysis of the days events (in my opinion). I thought a lot got missed in the “daily summaries”.

Well now, for all your political needs, the live blogs are a great place to go.

The first to really start the live-blogging of politics here in Oz, was Katharine Murphy with her “The Pulse blog” for Fairfax. She is now with The Guardian, and biased as I am because I work for it, she is still absolutely brilliant at it (except when I give her a bit of advice and it turns out to be wrong advice, as happened today – the moral being, shut up Greg, you’re in the way).

Her blog can be found each day here.

The Pulse is now being done by Stephanie Peatling, and it is also excellent. It also features great camera work by Alex Ellinghausen and Andrew Meares.

So if you’re wondering what is happening in the election at any particular point in the day, head there (and leave comments as well!).

***

So yeah. That’s a short post… ummm goodnight.

RBA drops cash rate to 2.75% (or How do you like those record lows?)

In a move which I didn’t see coming, the RBA today cut the cash rate by 25 basis points to 2.75%.

It came on the back of poor economic data such as today’s goods and services trade data which showed there was a pretty steep fall in import of capital goods – 21.7% in the past year which is the biggest drop since 2009.

Clearly as well manufacturing has been struggling  - notably seen by the rather awful AiG Performance Managers Index result in April fall 7.7 points to 36.7 – a long way below the 50 point mark which indicates production is steady:

The big problem form manufacturing is of course the Aussie dollar. Despite having previously rock bottom rates, the dollar remain stuck above parity with the US, and at near post-float record highs on the Trade Weighted Index:

In the RBA’s eyes, it needed to do something, and the biggest thing it can do is lower the cash rate.

The problem of course is that while America’s employment situation is starting to improve, its equivalent rate set by the Federal Reserve (the benchmark rate) remains stuck on 0.13% (where it has been since December 2008).

And rather annoying while the RBA has been cutting the cash rate, it hasn’t done anything to bring down the value of the dollar, despite this cut reducing the spread between our cash rate and the USA’s benchmark rate.

Essentially it seems it is not enough for our rates to go down to stop traders liking our dollar compared to the American, the yanks need to start doing some lifting as well.

But today see the RBA alerting the market that its prepared to work to get the value of the dollar down.

The difference can be seen in the statement issued today compared to last month.

Last month on the exchange rate, the Governor’s statement noted its stubbornness within a general paragraph about monetary policy:

There are a number of indications that the substantial easing of monetary policy during late 2011 and 2012 is having an expansionary effect on the economy. Further such effects can be expected to emerge over time. On the other hand, the exchange rate, which has risen recently, remains higher than might have been expected, given the observed decline in export prices. The demand for credit has also remained low thus far, as some households and firms continue to seek lower debt levels.

This month the exchange rate led its paragraph:

The exchange rate, on the other hand, has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates during that time. Moreover, the demand for credit remains, at this point, relatively subdued.

The subtle (or unsubtle if you spend time pondering the tea leaves of central banker's words) change from “higher than might be expected” to “which is unusual” pretty much suggests the RBA doesn’t think this is an anomaly that is going to sort itself out through normal market conditions.

But we have to realise as well that “normal” is a bit of a misnomer when we look at current monetary policy. The average of the cash rate for the past 5 years is now 4.23% – how low is that? Well back in 2004 when John Howard was boasting of record lows the cash rate was 4.25%, and it stayed at that rate for a mere 5 months before going back up.

So the monetary picture has changed not just a little but a lot. The 20 year average cash rate is now 251 basis points higher than the current rate.

Compare as well the cash rate to inflation”

Other than during the GFC, when the RBA cut rates ahead of drops in inflation, the only time we’ve had the cash rate this close to the inflation rate was back in 2001 in response to the Asian financial crisis. Back then when the real cash rate was 0.95 (ie the nominal cash rate was 95 basis points above inflation) the nominal cash rate was at 4.25% – a whole 150 basis points higher than now and the inflation rate was at 3.3% – compared to the latest rate of 2.2%.

Thus we are now in a position where the cash rate and the inflation rate are lower than at previous times when the RBA needed to run a similar expansionary monetary policy.

I noted this last year when I looked at the different level of the cash rate when underlying inflation is between 2-2.5%.

Times have changed. Normal is different to the old normal.

There’s not a hell of a lot of room for the RBA to move now. It can’t drop rate much more before it starts hitting the inflation rate. So in terms of stimulatory effects to the economy, most of the result from this rate will be through the secondary impact of the exchange rate declining.

Will it? Well the very early indications are good (note the times are GMT):

But that reflects more the market being taken by surprise. We shall have to wait to see if this drop in the cash rate finally gets the dollar heading down, or if the RBA needs to do more to let the market know it is serious about lowering the dollar – even if it means allowing inflation to rise.

And just a final thing. One of the wonderful things about the lowering of interest rates is it rather puts into sharp relief those who believe that Government debt causes interest rates to go up. As Tony Abbott said in April last year:

Everyone needs to understand that when the Government is out there borrowing $100 million every single day, there is going to be upwards pressure on interest rates.

Since then the cash rate has gone from 4.25% to 2.75%. The average mortgage rate has gone from 7.4% to around 6.2% (the lowest they’ve been for 10 years). Don’t you hate it when the economy turns out to be more complex than a sound bite?

I was just made aware that this morning on AM, Barnaby Joyce said this about the high dollar:

MARTIN CUDDIHY: The Coalition can't make it rain and you can't bring down the high Australian dollar, so how much realistically would change?

BARNABY JOYCE: …. You can not exacerbate where our dollar is by making sure that we keep down the amount of borrowing, because the higher our borrowing goes the more we have to attract funds in, the more our domestic interest rates stay high, the more our Australian dollar stays up. So you can actually affect the Australian dollar.

Ok then. Given the Govt borrows money by selling bonds, let’s have a look at the 10 Year Commonwealth Govt bond yield:

Yeah, the Govt is really having to raise rate to “attract funds”.

And yeah, I know. I know the next thing you say is “crowding out” where the Govt borrowing all this money is making it tougher for commercial lenders to raise finance. What did the RBA say about that today:

Financial conditions internationally continue to be very accommodative, with risk spreads reduced, funding conditions for most financial institutions improved and borrowing costs for well-rated corporates and sovereigns exceptionally low.

EXCEPTIONALLY LOW.

The RBA leaves cash rate at 3%

Today the RBA announced that it was keeping the cash rate steady at 3%

This is what the cash rate looks like over the past 20 years:

As you can see form the 5 years average we’re in pretty new territory. I can’t imagine what the cash rate at the 7.25% that it was in early 2008 would do to the economy now. The only way we would get back to that level is if the banks closed the margins between the cash rate and their interest rates. For while the cash rate is well below the 20 year average, the standard mortgage low is below it, but by a fair bit less than is the cash rate. The small business loan on the other hand is pretty much right on the 20 year average

That leads to these spreads:

All of which looks horrible, but as readers of this blog would know, there’s a bit more to bank financing than the spread of the cash rate to the mortgage rate.

Take the spread of the cash rate to the term deposit rate:

After 12 years of the term deposit for $10,000 for 6 months being LESS than the cash rate, it is now (assuming the banks don’t adjust their rates after today’s decision) it is 85 basis points ABOVE the cash rate.

Savers rarely get a mention when talking about the cash rate. They should.

Similarly compare the spread between the deposit rate and the mortgage rate:

And what we discover is that the mortgage rate is actually closer to the deposit rate than it was for the average of the Howard years – meaning if you want to get to the Howard Government average, either mortgage rates have to go up, or deposit rates have to go down.

Anyhoo let’s look at the statement, and compare it with March’s:

First GLOBAL CONDITIONS

 March:

Global growth is forecast to be a little below average for a time, but the downside risks appear to have lessened over recent months. The United States is experiencing a moderate expansion and financial strains in Europe are considerably reduced compared with the situation through much of last year. Growth in China has stabilised at a fairly robust pace. Around Asia generally, growth was dampened by the earlier slowing in China and the weakness in Europe, but again there are signs of stabilisation. Commodity prices are little changed recently, at reasonably high levels.

Now April:

Global growth is forecast to be a little below average for a time, but the downside risks appear to be reduced. While Europe remains in recession, the United States is experiencing a moderate expansion and growth in China has stabilised at a fairly robust pace. Around Asia generally, growth was dampened by the earlier slowing in China and the weakness in Europe, but again there are signs of stabilisation. Commodity prices have declined somewhat recently, but are still at historically high levels.

The big difference is the downside risk have gone from “lessened” to “reduced”. OK, maybe that’s not a big difference. But certainly in April the RBA is more negative towards Europe, stating it is in a recessions, rather than saying in March that the financial strains there are reduced from this time last year. The rest is basically a cut and paste.

Next, FINANCIAL MARKETS

March:

Sentiment in financial markets is much improved compared with the middle of last year. Risk spreads have narrowed and funding conditions for financial institutions are more favourable. Long-term interest rates faced by highly rated sovereigns, including Australia, remain at exceptionally low levels. Borrowing conditions for large corporations are very attractive. Share prices have risen substantially from their low points. However, the task of putting private and public finances on sustainable paths in several major countries is far from complete. Accordingly, as seen most recently in Europe, financial markets remain vulnerable to occasional setbacks.

April:

Internationally, financial conditions are very accommodative. Risk spreads are narrow and funding conditions for financial institutions have improved. Long-term interest rates faced by highly rated sovereigns, including Australia, remain at exceptionally low levels. Borrowing conditions for large corporations are similarly very attractive. Share prices are substantially above their low points. However, the task of putting private and public finances on sustainable paths in several major countries is far from complete. Accordingly, financial markets remain vulnerable to setbacks.

Geez, they really go in hard on the Australian Govt debt and how it is crowding out lending for corporations. Oh wait, sorry that was in the fantasy version of the statement written by the Liberal Party economic team. Note the aspect about “highly rated sovereigns”, and our historically low debt. How low?

Real low.

Next, DOMESTIC CONDITIONS:

March:

In Australia, most indicators available for this meeting suggest that growth was close to trend over 2012, led by very large increases in capital spending in the resources sector, while some other sectors experienced weaker conditions. Looking ahead, the peak in resource investment is approaching. As it does, there will be more scope for some other areas of demand to strengthen.

April:

In Australia, growth was close to trend over 2012, led by very large increases in capital spending in the resources sector, while some other sectors experienced weaker conditions. Looking ahead, the peak in resource investment is drawing close. There will, therefore, be more scope for some other areas of demand to strengthen.

Not much change other than the resources peak is now “drawing to a close” rather than the end of the peak “approaching”.  We should note, “peak” doesn’t mean end of mining.

Onto DOMESTIC SPENDING:

March:

Present indications are that moderate growth in private consumption spending is occurring, though a return to the very strong growth of some years ago is unlikely. The near-term outlook for non-residential building investment, and investment generally outside the resources sector, is relatively subdued, though recent data suggest some prospect of a modest increase during next financial year. Dwelling investment appears to be slowly increasing, with higher dwelling prices and rental yields. Exports of natural resources have been strengthening, though recent bad weather is affecting some shipments at present. Public spending, in contrast, is forecast to be constrained.

April:

Recent information suggests that moderate growth in private consumption spending is occurring, though a return to the very strong growth of some years ago is unlikely. While the near-term outlook for investment outside the resources sector is relatively subdued, a modest increase is likely to begin over the next year. Dwelling investment is slowly increasing, with rising dwelling prices and high rental yields. Exports of natural resources are strengthening. Public spending, in contrast, is forecast to be constrained.

Again hardly any change. Of note for those who know for a fact that spending under this government is out of control: “Public spending, in contrast, is forecast to be constrained”.

INFLATION:

March:

Inflation is consistent with the medium-term target, with both headline CPI and underlying measures at around 2¼ per cent on the latest reading. Looking ahead, with the labour market softening somewhat and unemployment edging higher, conditions are working to contain pressure on labour costs, as was confirmed in the most recent data. Moreover, businesses are focusing on lifting efficiency under conditions of moderate demand growth. These trends should help to keep inflation low, even as the effects on prices of the earlier exchange rate appreciation wane. The Bank's assessment remains that inflation will be consistent with the target over the next one to two years.

April:

Inflation is consistent with the medium-term target, with both headline CPI and underlying measures at around 2¼ per cent on the latest reading. Labour costs remain contained and businesses are focusing on lifting efficiency. These trends should help to keep inflation low, even as the effects on prices of the earlier exchange rate appreciation wane. The Bank's assessment remains that inflation will be consistent with the target over the next one to two years

In March there was an ever so slight worry about pressure on labour costs. IN April is becomes “labour costs remain contained”. It’s like watching Beckett’s tragically much ignored play, “Waiting for Wages Breakout”.

MONETARY POLICY:

March:

During 2012, there was a significant easing in monetary policy. Though the full impact of this will still take more time to become apparent, there are signs that the easier conditions are having some of the expected effects. On the other hand, the exchange rate remains higher than might have been expected, given the observed decline in export prices, and the demand for credit is low, as some households and firms continue to seek lower debt levels.

April:

There are a number of indications that the substantial easing of monetary policy during late 2011 and 2012 is having an expansionary effect on the economy. Further such effects can be expected to emerge over time. On the other hand, the exchange rate, which has risen recently, remains higher than might have been expected, given the observed decline in export prices. The demand for credit has also remained low thus far, as some households and firms continue to seek lower debt levels.

This month the RBA is really let everyone know that the easing of monetary policy is working – ie in their view to the extent no more easing is required. But they also notice that people aren’t borrowing all that much more than they were prior to the easing and that the exchange rate remains high despite easing of commodity prices. How high?

It’s times like this I like to recall the only time I have had a holiday in America was in June 2001.

CONCLUSION:

March:

The Board's view is that with inflation likely to be consistent with the target, and with growth likely to be a little below trend over the coming year, an accommodative stance of monetary policy is appropriate. The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand. At today's meeting, the Board judged that it was prudent to leave the cash rate unchanged. The Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the target over time.

April:

The Board's view is that with inflation likely to be consistent with the target, and with growth likely to be a little below trend over the coming year, an accommodative stance of monetary policy is appropriate. The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand. At today's meeting, taking into account the flow of recent information and noting that there had been a substantial easing of policy as a result of previous decisions, the Board judged that it was prudent to leave the cash rate unchanged. The Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the target over time.

The only difference was the addition of this in today’s statement: “taking into account the flow of recent information and noting that there had been a substantial easing of policy as a result of previous decisions”.

All in all the RBA paints a pretty good picture. Inflation steady, growth doing OK, wages steady, but with the dollar high. It wasn’t surprising that they didn’t move, given last month's big jump in employment numbers. But given everyone expects that to be revised down, and perhaps lead to an increase in the unemployment rate (although this is less sure, given the statistical changes by the ABS affect more the employment and participation numbers than the unemployment rate), it’ll be interesting to see if that changes their outlook.

On the basis of today’s statement though, I doubt it.

Banks: The Cash Rate and the Real Interest Rates

In my monthly round up of stuff to do with the RBA’s interest rate announcement I as a rule show this graph:

Now I must admit that by itself it is a bit misleading. It suggests the banks are making out like bandits, and are screwing mortgage holders royally.

In reality it only tells half of the story.

Today after tweeting a link to the graph, Stephen Koukoulas and Margaret Godfrey quite rightly suggested that I also graph the difference between mortgage rates and deposit rates. That’s a good idea – clearly if the spread of mortgage to deposit rates was increasing then a case could be made that banks are raising rates on mortgage holders (or lowering them by less than the cash rate is declining) while not doing the same for deposit rates. It’s also important because domestic deposits now account for over 50% of banks funding (prior to the GFC it was closer to 40%).

First off let’s compare the spread of 6 months term deposits to the cash rate:

Yes my friends, up until 2008, the rate for a 6 month term deposit was less than the cash rate. Now it is above it. This more than anything is why the first graph shows a bump from 2008 on. Prior to then, banks were laughing with respect to 40%+ of their funding. They were paying you up to 150 basis points less to hold your money than the cash rate. Sweet. But as you can see things started going a bit chaotic as the GFC neared, and then more expensive as the GFC hit. Now banks are paying around 100 basis point more than the cash rate to hold your money.

So obviously they have needed to get that extra money from somewhere….

So now let’s look at the difference between the mortgage rate and the 6 months deposit rate:

The current spread is 250 basis points – the average mortgage rate is 6.45%, the average 6 month term deposit is 3.95%. This spread is currently lower than the 304 basis points average for the term of the Howard Government.

Today when asked what he would do if the banks didn’t pass on the full rate of the cut, Tony Abbott pointedly refused to answer the question (because there’s bugger all he could do) but he said under Peter Costello the banks did what they were told (patent bullshit).

What has happened is that the funding mix has changed, and perhaps surprisingly the gap between what the banks are charging you to lend from them, and what we are charging them to lend from us (which is essentially what a deposit is) has shrunk of late, and at the very least is not much different to what it was when Peter Costello’s hand on the economic tiller. For Tony Abbott to say things would go back to the way they were under Howard and Costello is to suggest that actually not much would change in reality – but given the focus is almost always on mortgage holders rather than deposits (and I admit I am guilty of this as well) it’s an easy sell.

One last thing, let us look at the difference between the two rates – mortgage and deposit – and inflation:

First 6 month term deposits. This gives in essence the real return on your deposit. If the bank is giving you 4% and inflation is 2% then your real return is 2%:

Well what do you know. The real rate of return is currently 1.65% – the same as the average under the Howard Government – and that average includes the now abnormally high returns left over from the high interest rates under Keating. If you look from 2000-2007 however, savers were being mightily screwed compared to now.

But it’s good to know Joe Hockey and Tony Abbott want that to return. Incidentally any self-funded retirees out there whinging about interest rates going down etc, please stop it. The past 2 years you have been doing very well. You cannot expect to always get a real return of 3.5% from just sticking your money in the bank and putting you feet up. Be realistic. 1.65% is about .5% better than you would have average over the past decade.

OK now to see mortgages compared to inflation. Again this looks at the real cost. If inflation is 2% and the bank charges you 7% that is a greater real cost to you than if inflation is 5% and the bank is still only charging you 7%:

Again we find that the real rate you are paying for your mortgage is less than the Howard Government average. Again that average includes the big rates coming down from the Keating Government, but Joe Hockey likes to cites the average mortgage rate during that time, so what’s good for the goose…

All up I think these graphs nicely show that yes life has changed sine the GFC with respect to mortgages and their relation to the cash rate, but that actually things aren’t that much different, and an argument could be made that they are better – for both borrowers and savers.

Also remember as well – the RBA knows this, and as I pointed out yesterday, if the spread of the mortgage to the cash rate was lower, then the RBA wouldn’t have needed to lower the cash rate by as much.

RBA Cuts the Cash Rate to 3%

Today the RBA announced that it was cutting the cash rate by 25 basis points from 3.25% to 3.0%.

This now puts the cash rate at the equal record lowest level.

The cut was largely expected – so expected that this is the impact it had on the exchange rate:

The rate cut actually saw the exchange rate rise! Seriously, the Aussie dollar is absolutely bullet proof at the moment. Have a look at the comparison of the cash rate with the Trade Weighted Index over the past decade:

The cash rate falls are having no impact on bringing down the exchange rate and at best are perhaps only stopping it from rising more. This is really unprecedented in the post-float world.

Now the word thrown around will be “emergency levels” because the cash rate is now at the same level as it was in the GFC.

Well yes it is, but there are a couple big differences.

• Firstly, when the cash rate last reached 3.0% Australia’s annual GDP growth was 0.8%, the latest national accounts are out tomorrow and the GDP annual growth is likely to be around 2.7-3.0%.
• Secondly, back then the Government was implementing a historically large budget stimulus spend. This time round the Government is undergoing a historically large budget contraction:

What happened back then was that both the Government and the RBA were working to stimulate the economy; now only the RBA is doing it. Had the Government back in 2009 not spent so much on stimulus (as the Liberal Party suggested) it is likely the RBA would have had to lower the cash rate to around 1.5% to compensate. You can debate whether or not that would have been a better way to avoid the GFC (I don’t think it would have – I think it would have almost certainly led to a recession), but you can’t look at fiscal and monetary policy and suggest that the reasons for a 3% cash rate now are the same as the cash rate of 3% in the GFC.

Unless of course you are Joe Hockey and you have to say something bad about the the decision, but then he has to stand by a leader who says such things as this only a month ago:

'”the trouble with a government which cannot get the Budget back into surplus is that it keeps putting more pressure on households because a government which is out there borrowing, in this case, $20 million a day, is always putting unnecessary upward pressure on interest rates…”

So why did the RBA drop the cash rate? Well one indicator (as you’ll see in my Drum piece tomorrow) job growth is pretty much non-existent and today the building approval data showed nothing joyful:

And then yesterday there was the retail sales figures:

Pretty limp.

Now of course the big issue is what will the banks do. If they follow the past few rate cuts and only pass on 20 of the 25 basis points well end up with this:

The standard variable mortgage will be around 6.45% – well below the 20 year average of 7.70%, and even the Howard Govt average of 7.26%.

But the small overdraft for businesses is likely to only fall to about 10.1% – still above the 20 years average of 9.84%.

This will all lead to the spread of the bank rates to the cash rate increasing to obscene levels:

Of course if the spread was narrower it is unlikely the RBA would have actually cut rates to as low as they have.

When we look at the percentage of disposable income spent on interest payments for housing mortgages we see that while the cash rate might be low, the amount spent servicing mortgages is not. Although the recent drops in the cash rate should get the percentage of disposable income spent on interest payment to below 8% for the first time since December 2004 (not including the GFC), and a long way below the 11.1% it accounted for in December 2008:

Now to the RBA statement. Let’s do a quick comparison with this month and last month:

Global growth is forecast to be a little below average for a time. Risks to the outlook are still seen to be on the downside, largely as a result of the situation in Europe, though the uncertainty over the course of US fiscal policy is also weighing on sentiment at present. Recent data suggest that the US economy is recording moderate growth and that growth in China has stabilised. Around Asia generally, growth has been dampened by the more moderate Chinese expansion and the weakness in Europe.

The big change from last month is the addition of mention of the US fiscal cliff, otherwise there’s no change.

Key commodity prices for Australia remain significantly lower than earlier in the year, though trends have been more mixed over the past few months. The terms of trade have declined by about 15 per cent since the peak, to a level that is still historically high.

The difference is that in November the terms of trade decline was 13 per cent since the peak.

Sentiment in financial markets remains better than it was in mid year, in response to signs of progress in addressing Europe's financial problems, though Europe is likely to remain a source of instability for some time. Long-term interest rates faced by highly rated sovereigns, including Australia, remain at exceptionally low levels. Capital markets remain open to corporations and well-rated banks, and Australian banks have had no difficulty accessing funding, including on an unsecured basis. Borrowing conditions for large corporations are similarly attractive and share prices have risen since mid year.

No change except for a shift from “Financial markets have responded positively over the past few months…” to “Sentiment in financial markets remains better than it was in mid year”. Good luck working out if that is a positive or a negative!

In Australia, most indicators available for this meeting suggest that growth has been running close to trend over the past year, led by very large increases in capital spending in the resources sector, while some other sectors have experienced weaker conditions. Looking ahead, recent data confirm that the peak in resource investment is approaching. As it does, there will be more scope for some other areas of demand to strengthen.

Again, no change except for the inclusion of “while some other sectors have experienced weaker conditions”. Hardly a stunning statement.

Private consumption spending is expected to grow, but a return to the very strong growth of some years ago is unlikely. Available information suggests that the near-term outlook for non-residential building investment, and investment generally outside the resources sector, remains relatively subdued. Public spending is forecast to be constrained. On the other hand, there are indications of a prospective improvement in dwelling investment, with dwelling prices moving a little higher, rental yields increasing and building approvals having turned up.

Hardly any difference to what they said in November. A bit of different wordage, but not of meaning. Also just note “Public spending is forecast to be constrained”, which doesn’t really match the wasteful and spendthrift ALP line that the LNP would have you believe.

Now to inflation:

Inflation is consistent with the medium-term target, with underlying measures at around 2½ per cent. The introduction of the carbon price affected consumer prices in the September quarter, and there could be some further small effects over the next couple of quarters. Partly as a result of that, headline CPI inflation will rise above 3 per cent briefly. Looking further ahead, with the labour market softening somewhat and unemployment edging higher, conditions are working to contain pressure on labour costs. A continuation of moderate wage outcomes and improved productivity performance will be needed to keep inflation low, since the effects on prices of the earlier exchange rate appreciation are now waning. The Bank's assessment remains that inflation will be consistent with the target over the next one to two years.

The big difference here is that in November the RBA talked of higher than expected inflation figures. That now is gone. Clearly the RBA is untroubled by the inflationary impacts of the carbon price. And it certainly didn’t stop them from dropping rates.

And the conclusion:

Over the past year, monetary policy has become more accommodative. There are signs of easier conditions starting to have some of the expected effects, though the exchange rate remains higher than might have been expected, given the observed decline in export prices and the weaker global outlook. While the full effects of earlier measures are yet to be observed, the Board judged at today's meeting that a further easing in the stance of monetary policy was appropriate now. This will help to foster sustainable growth in demand and inflation outcomes consistent with the target over time.

Again little change with last month. Absent are mention of higher than expected inflation data and in November the RBA also noted

“Business demand for external funding has increased this year, the housing market has strengthened and share prices have risen in line with markets overseas.”

This month it is not so positive in its summation that it wanted to mention those aspects.

And so tomorrow the National Accounts come out and on Thursday the Labour Force data and we shall see how the decision to let monetary policy do all the heavy lifting is going.

The Reserve Banks keeps the cash rate at 3.25%

Today’s announcement by the RBA to keep the cash rate unchanged was a bit of a shock for most predictors. Certainly the foreign exchange market didn’t see it coming, with the dollar jumping around 0.60 cents against the US dollar within minutes of the announcement being made:

Of course just because economists get a prediction wrong doesn’t mean it should be that much of a shock. But it certainly suggests a more bullish outlook from the RBA than was expected.

Of course rates are still waaaay down low:

The cash rate remains over 2 percentage points below the 20 year average, and 1.38 percentage points below the 5 year average which now covers pretty much all of the Rudd/Gillard Government.

But to discover why the RBA made no change let’s have a look at the difference between the Governor’s statements from today and last month – and I’ll highlight the differences

First Global conditions:

November:
Global growth is forecast to be a little below average for a time. Risks to the outlook are still seen to be on the downside, largely as a result of the situation in Europe, where economic activity is still contracting. Risks elsewhere seem more balanced. The United States is recording moderate growth, while recent data from China suggest growth there has stabilised. Around Asia generally, growth has been dampened by the more moderate Chinese expansion and the weakness in Europe.

October:
The outlook for growth in the world economy has softened over recent months, with estimates for global GDP being edged down, and risks to the outlook still seen to be on the downside. Economic activity in Europe is contracting, while growth in the United States remains modest. Growth in China has also slowed, and uncertainty about near-term prospects is greater than it was some months ago. Around Asia generally, growth is being dampened by the more moderate Chinese expansion and the weakness in Europe.

The only real difference is the suggestion that US growth has gone from “modest” to “moderate” and China’s growth has moved from “slowed” to “stabilised”

Since October, the USA 3rd quarter GDP figure have come out showing a 2% growth in the past 12 months:

Which I guess is “moderate’

And China’s GDP growth came in at 7.4% for the same quarter, and does shows sings of “stabilizing”:

Now to commodity prices:

November:
Key commodity prices for Australia remain significantly lower than earlier in the year, though trends have been more mixed over the past couple of months, with some prices recovering some ground while others declined further. The terms of trade have declined by about 13 per cent since the peak last year, but are likely to remain historically high.

October:
Key commodity prices for Australia remain significantly lower than earlier in the year, even though some have regained some ground in recent weeks. The terms of trade have declined by over 10 per cent since the peak last year and will probably decline further, though they are likely to remain historically high.

Here the news is all bad. In October prices seemed to have regained some ground, today however the RBA was saying the “mixed”. In October the terms of trade had declined by “over 10 per cent”, now a more specific figure is cited – that of “13 per cent”.  But iron ore prices have increased since October. They’re now around $120 – up from around $100 in September.

Financial markets? Nothing at all has changed:

November:
Financial markets have responded positively over the past few months to signs of progress in addressing Europe's financial problems, but expectations for further progress remain high. Long-term interest rates faced by highly rated sovereigns, including Australia, remain at exceptionally low levels. Capital markets remain open to corporations and well-rated banks, and Australian banks have had no difficulty accessing funding, including on an unsecured basis. Borrowing conditions for large corporations are similarly attractive. Share markets have generally risen over recent months.

October:
Financial markets have responded positively over the past few months to signs of progress in addressing Europe's financial problems, but expectations for further progress remain high. Low appetite for risk has seen long-term interest rates faced by highly rated sovereigns, including Australia, remain at exceptionally low levels. Nonetheless, capital markets remain open to corporations and well-rated banks, and Australian banks have had no difficulty accessing funding, including on an unsecured basis. Share markets have generally risen over recent months.

Note as well that “Capital markets remain open to corporations and well-rated banks, and Australian banks have had no difficulty accessing funding, including on an unsecured basis.” (Just in case there are still a few people around trying to sell you the whole “the Govt’s debt is crowding out investors” theory.)

Now to domestic conditions.

Once again there has been next to no change in the labour market or in general growth since October. The RBA changed around the paragraphs a bit, but the wordage is the same:

November:
In Australia, most indicators available for this meeting suggest that growth has been running close to trend over the past year, led by very large increases in capital spending in the resources sector. Looking ahead, the peak in resource investment is likely to occur next year, at a lower level than expected six months ago. As this peak approaches, the Board will be monitoring the strength of other components of demand.

Some of the consumption strength in the first half of 2012 was temporary, but there have been some signs of ongoing growth, though a return to very strong growth in consumption is unlikely. While investment in dwellings has been subdued for some time, over recent months there have been some indications of a prospective improvement. Non-residential building investment has remained weak. Public spending is forecast to be subdued.

October:
In Australia, most indicators available for this meeting suggest that growth has been running close to trend, led by very large increases in capital spending in the resources sector. Consumption growth was quite firm in the first half of 2012, though some of that strength was temporary. 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.

Now we get to the big difference – inflation.

November:
Recent outcomes on inflation were slightly higher than expected, though they still show inflation consistent with the medium-term target, with underlying measures around 2½ per cent over the year to September, and headline CPI inflation a little lower than that. The introduction of the carbon price affected consumer prices in the September quarter, and there could be some further small effects over the next couple of quarters. With the labour market having generally softened somewhat in recent months, and unemployment edging higher, conditions should work to contain pressure on labour costs in sectors other than those directly affected by the current strength in resources. This and some continuing improvement in productivity performance will be needed to keep inflation low, since the effects on prices of the earlier exchange rate appreciation are now waning. The Bank's assessment remains that inflation will be consistent with the target over the next one to two years.

October:
Labour market data have shown moderate employment growth and the rate of unemployment has thus far remained low. The Bank's assessment, though, is that the labour market has generally softened somewhat in recent months.

Inflation has been low, with underlying measures near 2 per cent over the year to June, and headline CPI inflation lower than that. The introduction of the carbon price is affecting consumer prices in the current quarter, and this will continue over the next couple of quarters. Moderate labour market conditions should work to contain pressure on labour costs in sectors other than those directly affected by the current strength in resources. This and some continuing improvement in productivity performance will be needed to keep inflation low as the effects of the earlier exchange rate appreciation wane. The Bank's assessment remains, at this point, that inflation will be consistent with the target over the next one to two years.

In October the underlying measures were “near 2 per cent”; in November it was “around 2 1/2 per cent”. That difference was the key reason why the RBA held off dropping rates- they don’t want to be seen dropping rates while inflation possibly might be increasing unless the other signs in the economy (both here and abroad) are all negative. .

It agrees with what I suggested when the last CPI numbers came out, where I wrote:

The only aspect I think that might get the RBA to pause and not cut rates on Cup Day is that given the past 6 months has seen a combined 1.5% increase in the weighted median and a 1.3% rise in the trimmed mean the RBA might think that annualizes out to around the 3.0% – ie a the top on the band and thus decide it is best to wait and see what the December quarter holds before cutting the rates.

Not that this makes me a genius – I still predicted a cut in rates!

Now on to the conclusion, and a look at where the RBA sees monetary policy at the moment:

November:
Over the past year, monetary policy has become more accommodative. Interest rates for borrowers have declined to be clearly below their medium-term averages and savers are facing increased incentives to look for assets with higher returns. While the impact of these changes takes some time to work through the economy, there are signs of easier conditions starting to have some of the expected effects. Business demand for external funding has increased this year, the housing market has strengthened and share prices have risen in line with markets overseas. The exchange rate, though, remains higher than might have been expected, given the observed decline in export prices and the weaker global outlook.

October:

Interest rates for borrowers have for some months been a little below their medium-term averages. There are tentative signs of this starting to have some of the expected effects, though the impact of monetary policy changes takes some time to work through the economy. However, credit growth has softened of late and the exchange rate has remained higher than might have been expected, given the observed decline in export prices and the weaker global outlook.

They have changed from thinking rates are “a little below” to “clearly below” medium-term averages. With regards to home loans they are right, but with respect to small businesses, the rates remain slightly above average:

On this point it is worth noting that the spread of the cash rate to the small business overdraft rate actually increased in the past month:

It also mentioned housing prices which brings us to the House Price Index data released today by the ABS, that showed a 0.3% annual growth across the capital cities.

So not exactly a housing price boom, but I guess it has “strengthened” (given anything positive is stronger than negative).

Now to the end:

November:
Further effects of actions already taken to ease monetary policy can be expected over time. The Board will continue to monitor those effects, together with information about the various other factors affecting the outlook for growth and inflation. At today's meeting, with prices data slightly higher than expected and recent information on the world economy slightly more positive, the Board judged that the stance of monetary policy was appropriate for the time being.

October:
At today's meeting, the Board judged that, on the back of international developments, the growth outlook for next year looked a little weaker, while inflation was expected to be consistent with the target. The Board therefore decided that it was appropriate for the stance of monetary policy to be a little more accommodative.

The big differences – the higher than expected inflation data and the “slightly more positive” world economy (seriously, they must have been turning up the rose coloured glasses to “blinding” to think the world economy is more positive on the basis of China and the USA GDP growth.

And there the cash rate rests. Until December – at which point the market still expects there is a slightly better than even chance the RBA will drop rates to 3%.

CPI: Inflation up 1.4% in the September Quarter

And so the first lot of inflation figures since the introduction of the carbon price came out today, showing in the September quarter inflation had gone up 1.4%, for an annual rise of 2.0%. In seasonally adjusted terms it was even better – a 1.2% quarterly rise, with the same 2.0% annual rise.

Now normally figures showing a mere 2.0% annual inflation would have people laughing in the streets about the wonderful low price rising country we live in, but because of the carbon price these figures have caused many to scratch their chins and mutter “hmmm…”

First off let’s get some perspective:

Sure it’s 63 year’s worth of perspective, but I just want to reassure you all that we’re not exactly in hyperinflation territory. In fact we’re still at 2.0% right at the bottom of the RBA’s target of 2-3%. THE BOTTOM

So maybe we need a bit of a grip when we read thing like this from the Liberal Party:

These figures clearly show the impact the Carbon Tax is having on everyone across Australia.  The  things people need most like electricity, gas, education, rent, childcare and water are rising hitting the hip pockets of families, businesses, seniors and pensioners.

Now the Liberal Party is right (in part) when it talks about the rise in electricity prices (I’ll get to those later), but when it starts talking about “things people need”, well it’s not really being specific because the CPI covers the whole gamut (if you will) of things we need. And that whole gamut says annual inflation rose 2.0% over the past year – that’s a figure worth celebrating.

Let’s look closer – first the annual rate of the CPI over the past 7 years:

And now the quarterly changes over the same period (seasonally adjusted):

So annually things are fine but yep a big jump in the last quarter. And of course the carbon price is to blame. Treasury had predicted a hit of 0.7% due to the carbon price. Take that out and we’re back at either 0.7% non adjusted or 0.5% seasonally adjusted – or once again in very low inflation territory.

The big jump was in electricity (15.3%), gas and other household fuels (14.2%). Clearly these jumps were going to happen due to the impact of the carbon price. But how much? If you’re Joe Hockey, you’ll lay it all on the carbon price:

The ABS has found the largest price increases since the last CPI figures were released were electricity prices which have seen a 15.3% rise with household gas and miscellaneous fuels seeing a 14.2% rise.

Well yes that is true:

You would almost think that in the past quarter it was as if the government introduced something that meant gas and electricity suppliers were being charged for something that they had until then never been charged for… gee wonder what that is…

But first we need to realise that this was not a shock – in fact in June it was announced that NSW electricity prices would increase by around 18%, and gas prices would go up by between 9% and 15%. So there’s no surprise to any of this.

And remember as well that when those increases were announced only around 49% of that 18% rise was attributed to the carbon tax.

Some commentators have made a big deal about the rise for electricity being 15.3% when the Treasury (beware big pdf file) had suggested the one off hit from the carbon price would only be 10% for electricity and 9% for gas. But given 49% of 15.3% is around 7.5%, you could suggest that Treasury was overly cautious.

But one thing about the ABS data on sub groups such as these is that it is not seasonally adjusted – and the September quarter is often the biggest quarterly jump in price of the year (and the June one usually the smallest). Possum noted on Twitter that one way to look through the massive ups and downs of the original unadjusted data was to compare the increase in electricity prices in previous September quarter to gauge what we would normally expect such rises to be:

	Gas and other household fuels	Electricity
Sep-2007	2.4	4.3
Sep-2008	4.7	4.5
Sep-2009	2.8	11.3
Sep-2010	2.2	6.1
Sep-2011	3.8	7.7
5 September Average	3.2	6.8
Sep-2012	14.2	15.3
Difference from Average	11.0	8.5

So – assuming the difference in the increases are due only to the carbon price – it looks like the Treasury estimates were under for gas by 2% and over for electricity by 1.5%. But again remember not all of those price increases are due to the carbon price. Even if we suggest 50% of the rise is due to the carbon price (ie more than was the case in NSW) then the September quarterly jump is just 7.65% and is only a mere 0.85 percentage points above the 5 years average September quarter price jump for electricity.

Bear in mind this is a very unscientific way to examine the impact of the carbon price – and we’ll need to look at the next couple quarters to get a fuller picture, but it gives at least some sense of the picture. I wouldn’t bother doing it for all areas – eg fruit and vegetable where there are so many other variables at play – namely the weather.

But let’s get down to what everyone really care about inflation – the impact on interest rates.

And in annual terms:

or for a close look – the past 2 years only:

Given these are the measures the RBA focuses on, there’s not a lot here to suggest we need to panic about inflation.

The only aspect I think that might get the RBA to pause and not cut rates on Cup Day is that given the past 6 months has seen a combined 1.5% increase in the weighted median and a 1.3% rise in the trimmed mean the RBA might think that annualizes out to around the 3.0% – ie a the top on the band and thus decide it is best to wait and see what the December quarter holds before cutting the rates. But the market doesn’t seem to think that is likely – the expectation is still for a cut

On a broader look, the old Misery Index of the Unemployment Rate and Inflation rate added together shows we’re still in very good territory historically (I use the trimmed mean for inflation)

The level at the moment is 7.8, and as you can see, being under 8 is pretty much an anomaly. We are experiencing odd low unemployment and low inflation at the same time. With unemployment expected to tick up slightly, right now I’m still betting the RBA will drop rates in November. 

But then I rarely get things right on Cup Day…