Here's why Australia's 1.5% interest rates are too high

Tue, 05 Feb 2019  |  

This article first appeared on the Yahoo Finance web site at this link: https://au.finance.yahoo.com/news/heres-australias-1-5-interest-rates-high-002038269.html 

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Here's why Australia's 1.5% interest rates are too high

Australians love talking about interest rates and the bulk of economic commentary day-to-day is about whether or not the Reserve Bank of Australia will be putting them up, or down or leaving them steady at their next monthly meeting. This is no doubt linked to the huge interest of most Australians in house prices and the fact that household debt levels are amongst the highest in the world.

A small change in interest rates can have a significant impact on those with large mortgages.

Are interest rates too high or too low?

Having watching the RBA over the last 30 years or so, I have learnt a few lessons when it comes to working out whether interest rates are too high, too low or just right.

These lessons boil down to the following observable and easily tested facts on the economy.

If the economy is registering a decent rate of economic growth, say around 3 per cent, there are sufficient jobs are being created to keep annual wages growing by about 3.5 per cent and most importantly, annual inflation is hovering around 2.5 per cent and looks like staying at that rate, the prevailing interest rate is about right.

It seems simple when it is laid out that way.

Right now, economic growth is slowing to below 3 per cent and based on the data on housing, consumer finances and the global economy, it is probably on a path to about 2 per cent by the second half of 2019. Adjusting for population growth, the economy is getting uncomfortably close to a recession.

At the same time, wages growth is struggling to pick up from record lows and is stuck at a weak 2.25 to 2.5 per cent. This is too low and wages growth is being held back by the simple fact that there aren’t enough jobs being created to get unemployment and underemployment sufficiently low to spark a pick-up in wages.

Then there is inflation. The December quarter results released last week showed annual underlying inflation at 1.8 per cent. This confirmed that annual inflation has been below the bottom of the RBA target range of 2-3 per cent for 3 consecutive years and it has been below the mid-point of the target for 5 years.

This is the clearest indicator of all that interest rates in Australia are restrictive, or too high in other words.

Mortgage holders should shop around

It might seem odd to conclude this when the official interest rate is 1.5 per cent and most mortgage holders can shop around and get an interest rate around 4 per cent. But such is the change in the domestic and global economy in the aftermath of the global financial crisis. Inflation and therefore interest rates around the world are low.

Of all industrialised countries, the US has the highest interest rates at 2.5 per cent and there is a real possibility it will be cutting those rates at the end of 2019. Interest rates in Europe and Japan are negative. They are 0.75 per cent in the UK and in Canada, rates are 1.75 cent.

In an ideal climate for Australia, GDP growth should be higher, wages growth stronger and inflation should be above current levels.

It’s not rocket science to work out a formula to work out how policy makers in Australia could achieve that – lower interest rates are the answer.

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THE LATEST FROM THE KOUK

Here's why you need to buy a house NOW

Wed, 29 May 2019

This four part series on housing first appeared on the Yahoo website during March 2019 at these thinks:

Part 1: https://au.finance.yahoo.com/news/heres-need-buy-house-now-003308014.html 

Part 2: https://au.finance.yahoo.com/news/buy-house-live-late-043710857.html 

Part 3: https://au.finance.yahoo.com/news/many-australians-regret-buying-house-none-234007432.html 

Part 4: https://au.finance.yahoo.com/news/buy-house-hold-10-years-203418110.html 

 It outlines the case why it is a good time to buy a house. Any comments and feedback welcome!

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Part 1. Here's why you need to buy a house NOW

It would be a great shame if the current weakness in house prices does not see those groups previously frozen out of the housing market step up and buy a house to live in.

Whether it is in Sydney, Melbourne, Perth, Darwin, Canberra, Brisbane, Adelaide or regional Australia, housing affordability is improving rapidly with prices generally lower, mortgage interest rates remarkably low and competitive, and wages growth edging up in a steady if not spectacular way. Sure, saving that deposit for a house is still hard and the banks and other financial institutions are making it a bit more difficult to get the loan you need to buy your house.

But for many reasons, getting into the housing market now or in the next 12 months to buy your house to live in will set you on course for a life of fulfilment and financial security.

I want to set the scene with a few definitions – when I say “houses” and “house prices”, I am referring to all dwellings – that is free standing houses, units, townhouses and apartments. It is a generic term. And to make it clear, I am suggesting buying a house for you to live in, not to invest in, which is an entirely different kettle of fish.

Change of view on interest rates

Fri, 24 May 2019

Having been the only economist to correctly anticipate an interest rate cut from the RBA when close to 50bps of interest rate hikes were priced in to the market last year (See Bloomberg 17 August 2018), I have agonised over the exact months the cuts would be delivered and then how many rate cuts would be needed to reflate the economy.

Recently, I was of the view that the RBA would need to cut 100bps from now, to a level of 0.5%, but I did so with relatively low confidence. This is why I recommended all clients to close their long interest rate positions on 17 April 2019 (when the implied yields were 1.10% for the mid 2020 OIS; 1.35% on 3 year yields and the Aussie dollar was just over 0.7000 at the time).

Like in most good trades that were massively in the money, I left a little money on the table while I reassessed the outlook.

Since calling for interest rate cuts from the RBA, a lot of water has passed under the bridge, especially in the last few weeks.

Events mean I am changing my view on interest rates and have been placing / will be looking to implement new trades.