What happens if the RBA lowers interest rates?

The ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve is forecasting two cash rate decreases of 0.25 percent in 2019.

The call for rate cuts seems to have picked up velocity after “celebrity” economist Shane Oliver (the one with the terrible dyed blonde hair) started making noises about the need for rate cuts. As the sage of Omaha once said, “economic forecasters exist to make astrologers look good”.

Christopher Joye, portfolio manager with Coolabah Capital Investments, has been one of the very few commentators to have been highly critical of the Reserve Bank of Australia’s insane policies. A quote from Coolabah’s web site:

Needless to say, the RBA is doing its best to once again irresponsibly inflate the hazards to which prudent investors are subject. It is quite staggering that with a 5.5 per cent jobless rate, which is a sliver above full-employment, and headline inflation within the RBA’s target band, that the central bank nonetheless deems it appropriate to impose a negative real cash rate on savers.

Other more sensible central banks around the world understand that if you keep rates too-low-for-too-long you inevitably blow asset price bubbles, an observation that has been completely lost on a myopic and immensely arrogant Martin Place, which is preternaturally incapable of admitting it is wrong.

Oh no, the rate cuts in 2016 had nothing to do with the “surprising” and striking re-acceleration in national house price growth back to double-digit rates in the months that followed. No, that was all about housing supply. Seriously Phil, bite the bullet brother.

I couldn’t agree more.

The RBA is now so addicted to the drug of inflated house prices that it is seriously contemplating rate cuts to an already artificially low rate when there is no recession and employment is as good as it has been in this country for at least 50 years! And this is all because people might feel a little poorer because their houses in Sydney and Melbourne have decreased in value by perhaps 10 percent or so, after a run up of 60-70 percent in recent years! It’s patently absurd.

Then the RBA Governor, Philip Lowe (a real life version of Nassim Taleb’s “Dr. John” character), had the audacity to call on employers to lift wages. They need to lift wages because many people in Sydney and Melbourne cannot afford to buy a house and are being hit with sky high energy prices – both of which are a direct result of government policy! 

The problem is, employers are not responsible for the breathtaking incompetence of government and they are already struggling under the burden of Australia’s already high average weekly ordinary time earnings (AWOTE), so dream on Phil – it’s not going to happen. (And if the jingoistic Bill Shorten wants to lift the minimum wage, go ahead, business will simply employ less people.)

At this point, the attempt to micro-manage the economy through the blunt instrument of interest rates is neither necessary nor ultimately effective. And let’s please remember that the majority of Australians own their own home or rent, those with a mortgage are in a minority (but are always pandered to by self-serving politicians and their factotum public servants).

The RBA has already lost significant control over interest rates. Approximately half of Australian bank funding is sourced from offshore (largely the US) and is thereby beholden to the rates that fund providers in those offshore debt markets require. A relative of mine who is a banker, told me on the weekend that if the RBA does cut rates, the banks are unlikely to pass on any more than 10-15 basis points (if they can even manage that). 

The cheapest funding source for Australian banks is domestic household deposits. These deposits finance approximately one third of the banks’ total funding needs. Most of this money comes from self-funded retirees and high net worth individuals (not always mutually exclusive groups). As pointed out by Coolabah Capital Investments, after tax, the return on these deposits is negative, i.e. below inflation.

Now, if the RBA cuts rates and banks choose to reduce rates on household deposits (i.e. term deposits) at the same time that a federal Labor government is in power (and has taken away the refunds on excess franking credits*), bank depositors will be forced to move part of this money out of the banks and into alternative (higher yielding) investments. Banks will then replace deposit funding with more costly funding sources such as hybrids and offshore funding, which in turn could result in independent bank rate rises. The exact opposite of what the nutcases at the RBA are trying to achieve.

This of course will all take time to play out, but it will happen if the RBA and the Labor party are stupid enough to do what we are supposing they will do.

Another casualty will be the Australian dollar. If the RBA actually makes two 25 basis point cuts, there is no way the Australian dollar will stay in the 70s against the US dollar. In recent times, backing the US dollar against the Australian dollar has been like shooting fish in a barrel.

Australia is a large net importer of manufactured goods and petroleum and this will result in price inflation on these goods, once again hitting the average person in the hip pocket.

With friends like the RBA and the Australian Labor Party, who needs enemies?

* Does anyone actually think that a Labor government will responsibly utilise the billions they think they are going to save from the abolition of refunding excess franking credits? And to all those younger people with self-funded retiree parents or grandparents who are thinking that all of this won’t affect them – like a thief in the night, the Labor Party is about to steal a good part of your inheritance.