Will rates go up? Will rates go down?
Come in spinner!
There’s a lot of people talking interest rates in both directions right now.
The inflation data last week sparked a few rounds of grumble and rumbling that maybe a rate hike was now on the cards. A few eyes were watching the fall of the coins very nervously.
Could that be true? Are rates on the rise?
It’s true that the inflation figures did come in stronger than expected, but not by a lot. Headline CPI rose by 1.0 per cent in the September quarter, to be 2.3 per cent higher over the year.
That’s still squarely within the RBA’s target band.
Remember, the RBA targets annual inflation of between 2 ~ 3 percent.
But it’s the quarterly strength that took a few people by surprise. Annualise that rate and you’re looking at inflation of 3.5 ~ 4 percent. A CPI print of 4% would likely be enough to provoke an immediate response from the bank.
4 percent is way outside the target band, at least by the standards of recent experience (though of course some countries would be very happy with inflation of 4%!). The RBA has one of the best track records in the world in terms of hitting its inflation targets, and inflation’s been anchored firmly to the target band for almost twenty years.
It’s a stellar achievement.
In fact, inflation’s pretty much fallen from the public mind. No one really worries about it any more. I wonder if a lot of people even remember that that inflation is the RBA’s primary focus.
It’s not the economy, as such. Ideally it wants to keep a lid on inflation AND keep the economy humming along.
But if push came to shove, and the RBA had to chose between inflation and growth, it’d shoot for inflation, every time.
In fact, that’s the agreement it has with the government. The RBA, like pretty much every central bank in the world now, is an inflation targeter.
The idea is that interest rates on their own can’t be used to fix both inflation and growth. Sometimes, it’s one or the other.
And a key force keeping inflation down is the belief itself that inflation is going to stay down. Inflation expectations have a huge impact on inflation outcomes.
So the policy response to inflation needs to be ‘credible’. But credibility only comes if the public believes that if push came to shove, growth would be sacrificed for the sake of keeping a leash on inflation.
It sounds a bit scary, but it’s a doctrine that has served us incredibly well. With inflation and inflation expectations anchored to the RBA’s target band, we’ve been able to bring rates down to 50-year lows.
That has freed up the financial sector. With capital flowing more freely to business (and of course to investors like us), the economy has expanded quickly.
Everyone’s a winner.
But these wins did not come cheaply. Central banks had to ‘break the back of inflation’ first. That meant super high levels of rates, which meant recessions and a very grizzly public.
So the RBA would be very unwilling to let their hold on inflation be taken from them. Once it’s gone, it’s expensive to get it back.
And so you’d still have to think Glenn wouldn’t be thinking twice if push did actually come to shove.
I’m sure Glenn’s been happy to be every body’s hero with the rates cuts we’ve seen under his watch. But I’ve seen that steel in his eye. He looks to me like a man who’s as happy kicking heads as he is handing out flowers.
And he knows that his reputation, and the bank’s credibility, is built upon him doing just that.
And everybody in the markets knows that too. So that’s why a stronger than expected CPI print, sent a quick shiver down people’s spines.
brrrrrr.
So is a rate hike on the cards now? Could the RBA be forced into raising rates at the same time as the AUD bumps back toward parity, and growth outcomes remain soft?
It’s not a pretty scenario.
Personally, I don’t think it’s something to worry about for the time being. And I certainly don’t think they’re hitting the panic buttons down at Martin Place just yet.
Partly the CPI data had a couple surprises, but if you look at the ‘underlying’ (more stable) inflation measures, there’s no sign of an inflation break out there.
Second of all, a higher AUD actually offsets some of the risk of inflation.
That is, if the AUD is stronger, the things we buy overseas are cheaper for us, which means the final price when those goods hit Australian shores, is cheaper. Inflation falls.
So the increases we’ve seen in the Aussie dollar in recent months, will in the next 6 months or so, put back some downward pressure on inflation.
And if inflation remains a non-issue, which I expect it will, that puts the focus back on growth outcomes. And as the RBA noted in the last minutes, economic growth is still expected to remain “below trend over the next year or so.”
And at the same time, the AUD keeps pushing higher. And with a taper to Quantitative Easing now pretty much completely off the table in the US, there’s nothing driving US dollar strength, which means we could see the AUD trade even higher against the Yankee Doodle.
If that happens, and that happens before the a solid pick up in non-mining investment, particularly housing construction, then I think the RBA will have no choice but to cut rates even further.
But it’s too early in the game, and too late in the year for the RBA to do anything about that now. They’ll want to see how it plays out in the near term, and will be closely watching what happens to retail sales through the Christmas period.
If the Grinch is haunting Christmas, then I reckon we’ll see another rate cut, possibly in March or April next year (of course, in the absence of any other major surprises).
And so as investors, we can take heart that rate hikes still remain a long way off. And that also means that the fire that’s been lit under the property market will be left to run on full bore.
And the emerging boom in property we’ve seen will just keep charging ahead in the time being.
So let the CPI data be a reminder. At some point, the RBA may need to raise rates. That’s what they do. We need to build that into our planning.
But for the time being, under the firm hand of captain Glenn, it’s steady as she goes.
Ken. says
If rates do go up, I personally would be looking squarely in the eyes of the new Federal Government.
Sieg Scherrer says
a stronger AUD does impair on exports, mining, manufacturing, and so on. rising interest rates will strengthen the AUD.
Tom says
There is one influence which has not been mentioned here. USA!!!
QE is about to be tapered. The US financial world will get cold feet. They have been very jumpy for several years, balking at every little hint of any change. Their stock market has been on a roller coaster. Their banks are shit scared they’ll get caught out again, so soon after the GFC; but they have not learned their lesson. GREED IS GOOD!!!
The enormous amount of money which their Government printed, with the aim of stimulating their own domestic US economy, has largely been taken up by their banks. But instead of bolstering business and infrastructure at home, they have sent it overseas, where they have been able to get higher returns.
The Government would have been far better off arranging for the newly printed money being loaned at very, very low rates, even interest-free, to businesses directly, rather than via the corrupt financial institutions, which caused the problems in the first place. By targeting the cash, they would have ensured it did what it was intended to do – boost the local economy.
Now, with the inevitable tapering off of the QE program, the supply of money will begin to dry up, (relative to what they have become accustomed), which will cause their interest rates to increase, making the home market more attractive and causing money to be repatriated.
When the money is repatriated, the long-term effect of blindly printing money will come home to roost. Each dollar printed must dilute the intrinsic value of each other dollar. This has been masked by the cash being sent overseas. But when it returns, it will cause inflation in USA. That will force the $AUD up again, causing even more problems here.
The US knows it cannot continue just printing money, without it coming back to bite their bum. When it does, the shit will hit the fan – and we will all be covered with it.
Meanwhile, in order to ameliorate the exodus of cash, countries like Australia will have to raise rates in parallel. This effect is almost completely independent of any locally-caused rate movements, such as Jon has considered here.
So, before borrowing any more money, make sure you allow for several percent increase, as a buffer against the inevitable. If you would not be comfortable with a 3% rise on ALL your borrowings, go back to the drawing board. Hopefully, that 3% buffer will not all be required any time soon, but it’s on the cards. I hope our Reserve Bank have contingency plans worked out. It’s not a matter of “IF” it’s a matter of “WHEN?”
dean says
Tom hits it on the Nail. Not if but when. and 3% could be conservative…but at 3% on a 400,000 dollar loan thats another 12,000 dollars a year to find..about 33 dollars a day. Try passing on that increase to ya tenants. See how ya go.
To blame the new aussi fed govt for the mess is of course way too simple, and is sadly failing to account for the greatly increased internationalisation of the fiscal market… Abbott and his motley crew are but puppets to an increasingly corporatised and fiscally tangled cross borders and nations and cultured mess called the global economy..
Those that dont believe things have changed and markets are any different than the past, are sadly, disillusioned.
When America farts, poor wee aussi’s gonna soil its linen…..
Interesting times. Investing is not the easy thing of the past when easy credit and the decoupling away from the gold standard made anyone who bought real estate a winner. The scene is far more complex and nuanced now.
Total agreeance with Tom. If ya cant factor in a comfortable margin before positive cash flow becomes negative, stay well away, or you could well be burnt.