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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My house price bet – I’m very happy and getting ready to collect

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Just to reiterate, the bet centred on Locantro’s view that prices would drop 35 per cent or more by the end of 2021 from the peak levels in 2017, a forecast that looked absurdly pessimistic given the raft of factors that influence house prices over the course of years.

For Mr Locantro to win the bet, house prices measured by the Australian Bureau of Statistics on a quarterly basis in either Sydney, Melbourne or for the average of the eight capital cities would need to fall by 35 per cent or more from the peak levels by the time the December quarter 2021 data are released. The ABS released the latest residential property price data last week which presents an opportunity to see how the bet is unfolding, admittedly with three years to go until it is settled.

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Get ready for a cash rate cut in April

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This article first appeared on the Yahoo Finance website at this link: https://au.finance.yahoo.com/news/get-ready-cash-rate-cut-april-193244245.html

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Get ready for a cash rate cut in April

The data is in and it is compelling.

The Australian economy is faltering and the risk is that it will weaken further if nothing is done to address this decline.Not only has there been recent confirmation of a per capita GDP recession – that is, on a per person basis the economy has been shrinking for two straight quarters – but inflation is embedded below 2 per cent, wages growth is floundering just above 2 per cent, house prices are dropping at 1 per cent per month and dwelling construction is in free fall.

Add to this cocktail of economic woe an unambiguous slide in global economic conditions, general pessimism for both consumers and business alike and a worrying slide in the number of job advertisements all of which spells economic trouble.Blind Freddie can see that there is an urgent need for some policy action. And the sooner the better.For the Reserve Bank of Australia, there is no need to wait for yet more information on the economy.

It has been hopelessly wrong in its judgment about the economy over the past year, always expecting a growth pick up “soon”. Instead, GDP has all but stalled meaning that inflation, which is already well below the RBA’s target, is likely to fall further.In short, no. It is not like a 25 basis point interest rate cut on 2 April and another 25 in, say, May or June will reignite inflation and pump air into a house price bubble.

Such a claim would be laughable if there are any commentators left suggesting this.