EYE-BALL Guru on – Why the RBA errs on Interest Rate policy …

December 7, 2011
Why the RBA errs on Interest Rate policy …
The RBA did the expected yesterday when they cut another 0.25% of official interest rates.  The big four majors – CBA, ANZ, WBC and NAB have yet to respond to the decision.  The delay has given media outlets plenty of copy in today’s tabloids.

The fear is ‘flight of capital’.  For many years the RBA have given off-shore investors every reason to invest in the A$ and its high interest rate policy as compared with many of our major trading partners.

Keeping that capital in Australia is the priority of the RBA when it comes to setting official interest rate policy.  There can be no other reason – a quick survey of interest rate levels in the major economies of the world are reveal in the Trading Economics linked graph below:

Major Nations Interest Rates

Clearly the gap between interest rates of the major western and developed economies show Australia as a most attractive option for off-shore investors. The RBA and Treasured Swan have given glowing and welcoming reports about the committed A$250 odd billion investment in Australia’s future resource developments by off-shore investors. This capital investment is one of the reasons the A$ remains high relative to its long-term mean average of around A$0.75c … see chart below …

A$ historical chart

For two decades now the RBA have believed they are fighting a war on ‘inflation’ – since 2007 and the commencement of the GFC this preoccupation has hurt Australian mortgage holders to the tune of $10’s thousands of dollars.   In essence – the offshore investors who are enjoying the high interest rates relative to their own economies – and the appreciation and continued high value of the A$ – have ripped the heart out of the Australian mortgage sector who have been forced to pay the higher interest rate price that the RBA deemed necessary to fight inflation – see Trading Economies chart below for major economies inflation rates  –

Major Nations Inflation Rates

The RBA is an institution that operates under a charter agreed to by both sides of Government.  That charter is heavily weighted toward the fight in inflation and the management of the economy to keep inflation within a narrow band.  This mandate appears in part below as copied from Wikipedia sources

RBARoles and responsibilities
Reserve Bank of Australia in Canberra

It is currently governed by the Reserve Bank Act 1959, which was approved by Parliament. The Reserve Bank Board’s duty stated in the Act, within its outlined boundaries, is to ensure that the Bank’s monetary and banking policy is used to help the Australian population. This should be accomplished through consultation with the Government and so in the Reserve Bank Board’s opinion that its powers are used to help with:

  1. the stability of the currency of Australia
  2. the maintenance of full employment in Australia; and
  3. the economic prosperity and welfare of the people of Australia.

In practice the Reserve Bank concentrates on the first objective, that is to control inflation through monetary policy. The current objective is a policy of inflation targeting aimed at maintaining the annual inflation rate at between “2-3 per cent, on average, over the cycle”. This target was first set in 1993 by the then Reserve Bank Governor Bernie Fraser and was then formalised in 1996 by the then Treasurer Peter Costello and incoming Reserve Bank Governor Ian Mcfarlane.

When Australia’s big four Banks play with the value of how much of any rate cut they elect to pass on to their mortgage holders – again the mortgage sector suffers for their Banks need to deliver profitability  to its shareholders above a fair outcome to their customers.

The collective A$30 billion plus profit performance announced by these same four Banks in their current reporting period make light of comparisons in how these four Banks are struggling to shore up balance sheets as are the other global Banks around the world.

The recent S&P downgrade of these same four Australian Banks has been largely shrugged off – yet the continued reporting of falling property prices across Australia’s major cities renders the 60% portion of the Banks residential loan book tethering on the brink of further negative equity equations.  The other on-going claw that contributes to the ratings downgrade is the lift in mortgage delinquencies in the last 6-9 months.  In essence borrowers are falling behind on their loan repayments – yet the Banks continue to accrue the debt.  When the music stops and these Banks are forced to deal with the reality – their balance sheets will begin to collapse and that is why they are reluctant to pass on the full measure of RBA rate cuts.

The Banks have announced they will have to pay higher borrowing costs to roll over their maturing off-shore funding – and this leads to the reluctance  for them to pass on the full RBA rate reductions.  Treasurer Swan beats is chest to try and intimidate the Banks but his is a hollow gesture – he and the RBA have their mandate wrong as are their reasons to keep the A$ at such high levels.

Meaningful policies that suit Australian’s business interests and its export economy where we increasingly rely on export revenues from our resources and agriculture,  would fare far better off to the tune of A$100’s billions in export revenues – if the A$ was nearer its mean average – see chart above.   The continued high dollar has also crippled the tourism, manufacturing and retail sectors.

In these economic matters both Treasurer Swan and the RBA have been asleep at the wheel and are working on a false premise that ‘inflation’ is the enemy – this is ridiculously stupid in the extreme …

The high dollar high interest rate policy allows off-shore investors to park their liquid funds and siphon off Australia’s wealth with the only penalty being a weak and avoidable ‘withholding tax’ levy.

Australia’s mortgage belt is hurting and that is further pressuring mortgage defaults that will have them revisit the 1992-5 recession where Bank mortgage sales reached all time highs.   This downward spiral will add more pressure on house prices which in turn creates self-fulfilling pressures on the increased negative equity equation.   The spiral effect is like a developing black-hole within the Australian mortgage sector and it is a real and ever widening crisis.

This should be the real concern for the RBA and Treasurer as they continue with their flawed and stupid interest rate and high dollar policy to fight inflation.

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