Wednesday, February 3, 2010

Miranda’s Assets Command A Higher Rate Of Interest

Yesterday’s decision by the Board of the Reserve Bank of Australia to leave official interest rates unchanged caught just about everyone by surprise. So certain were most commentators that they had most likely already written their editorials explaining why the 25 basis points increase was inevitable. But instead, they must have found themselves scrambling to find an explanation for such an unexpected turn of events. Then, when the stunning news was revealed, the Aussie dollar fell, the share market rose, except for the shares in the big banks who would have profited from any rate rise. All this over a decision where nothing happened. Is it possible that we are all over reacting just a little to the movements, or in this case lack of movement, in interest rates?

At 3.75% the current cash rate remains well below the so called “neutral range”, which is supposed to be the zone where the balance between supporting economic growth and holding back inflation is maintained. While there have been signs of strong economic growth, declining unemployment, and new signs of emerging inflation, all of which would point to the need for an increase in interest rates, those factors only tell part of the story. The Reserve Bank’s own explanation is that the retail banks have already put interest rates up independently, reducing the need for the regulator to take action. But there is more than that going on.

Despite the signs of economic recovery, there remains a number of serious challenges for the economy. Most significant is the continued decline in business credit, with businesses who can reducing their exposure, and businesses who need funding finding it increasingly difficult to obtain. If that continues, the strength in jobs growth could quickly evaporate. At the same time, the housing shortage appears to be creating a bubble in home prices, but jacking up interest rates isn’t going to make it any easier to build more houses, in fact quite the opposite. It is also important to realize that the overall strength of the Australian economy is not spread evenly across the board over all sectors, or all geographical areas. Some areas are faring well, while others continue to struggle.

Finally, there are offshore factors which are in some ways less predictable, and certainly less manageable, but which are capable of having an enormous impact on the Australian economy. A great example of that is China, where ongoing demand for our resources is a major contributing factor to our prosperity while much of the rest of the world is in the doledrums. It is something over which we have no control, but from which we benefit greatly. But that’s a two way street, and should anything happen to China there goes a big chunk of our economic stability. Similarly, adverse events in other parts of the world can and do hit home here, as we have seen in the past two years, and right now there is continuing concern about sovereign debt issues in several parts of the world. Any significant defaults in that regard can also impact upon conditions here.

Altogether, although the Reserve Bank decision was an unexpected one, it is probably the right one, especially if they know something about international sovereign debt issues that the rest of us don’t. The fact is that as long as the economic recovery continues, we will see interest rates rise, and that should not be any surprise. But just because they didn’t rise yesterday shouldn’t be seen as anything terribly significant one way or the other. Perhaps the only one who really got it right yesterday was the Macquarie Bank Trader who was caught out on national television looking at photos of supermodel Miranda Kerr. Obviously her assets command a much higher rate of interest.

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