Interest Rates can be tricky


Interest rates and monetary decision making processes are complex things. Sometimes you’ve just got to close your eyes and hope it all pans out the way you want it to…

Interest rates decision

So it seems that in the latest Reserve Bank of Australia (“RBA”) monetary decision, interest rates were dropped from 1.75% to 1.50% because there’s room for the economy to grow faster… does anyone else find that a little strange? Isn’t that more the job of the government policy? In other words, if the economy IS growing, and employment is ok and inflation is under control THEN isn’t it the job of government policy to set the conditions for private enterprise and workers to take advantage of those stable economic conditions? My suggestion is a highly arguable one that would stimulate much disagreement amongst any group of learned economic souls but regardless, i’m fairly comfortable to put the suggestion out there. And why do i bother you with such nonsense?

The RBA has released it’s Statement on Monetary Policy and the document makes for an interesting read. The time-challenged may choose to simply read the introduction, which is highly informative in itself. From my own little corner of the world, the drop in interest rates makes no sense unless you look at it in the context of the Central Bank deciding that the government isn’t doing enough to kick along the economy, so the Central Bank has to step in a do a bit of the government’s work.

Here’s the final wording of the overview from the statement…

“The data coming to hand since then have not altered the outlook for output and unemployment, and confirm that inflation is likely to remain below 2 per cent over most of the forecast period. While the prospects for growth in economic activity are positive, there is room for even stronger growth. Also, recent information implies that dwelling prices have been rising modestly over the course of this year and confirms that growth in lending for housing purposes has slowed since last year. All this suggests that the risks associated with high and rising household sector leverage and rapid gains in housing prices have diminished.”

Interest Rates Decision In Michael-ese…

“Things are actually not too bad. The world isn’t falling apart and on a reasonable read, doesn’t appear to be likely to do so. Locally, employment is ok, and inflation is lower than our target band. But there’s a trend towards more part-time employment and lower hours worked, so we think there are a few pressures on the economy that may not be showing up on the surface. It doesn’t look like the government is going to be be in a position to do much about that – so we’ll give the economy a little kick along by lowering rates for residential borrowers. Even though we are terrified of a housing price bust-up, we’re hopeful that people won’t use lower rates as a reason to go out and borrow heaps for more housing. Oh – and we’re going to assume that a drop in local rates will make our dollar just a little less popular, to help keep our export income up there.”

So sometimes you are making a decision while simultaneously closing your eyes and holding your breath.

interest rates michaels musings rba monetary decision making process close your eyes and hold your breath

So sometimes you make a decision while simultaneously closing your eyes AND holding your breath..

Interest Rates and Housing Worries

To put some figures behind the Reserve Bank’s worry about residential housing debt levels, and why there is quite a bit of argument about Australia’s housing and associated debt, i’ve linked a few articles by more authoritative figures than moi… Keep in mind that these are all harping on the negative of household debt and i am not suggesting that any outcome is more likely than another (simply because i believe that there are too many variables of the known and unknown kind, so any statement about the future is at best, a guess). However, it is very important to be aware of the range of opinions out there at any given point in time.…/…/n…/55f9bad92c99869ceacdb76a5adc08d4…/australia-headed-for-recess…/7674154

If you’ve taken the time to read these links then you will see why the RBA would be worried about debt levels for residential housing. Australia’s “household debt” has risen dramatically since the GFC from 150% to now sit at 210% of GDP. You don’t have to be an economist to see that this is a big figure when you realise that the USA’s equivalent has fallen since the GFC and now sits at a bit over half Australia’s figure – Australia’s problems aren’t really related to government deficits and debt, they’re more related to household debt and household incomes.

The RBA is highly aware of this vulnerability in Australia’s finances and have run a number of scenarios and investigations to obtain more precise figures. Some of these were good news – as they suggest a higher proportion of Australia’s housing debt is held by higher income households, who have more capacity to deal with debt, and a large number of households are ahead with their mortgage payments or are using lower rates to reduce their overall debt. So all is not dire. It’s just prudent to be careful when an indicator reaches levels that are globally significant.

Back to Interest Rates and this recent reduction

The major banks refused to pass on the full rate cuts, as they aim to use part of that money to help offset higher funding costs for their own ability to attract money, and to help keep shareholder profits high. So arguably, a large chunk of benefit from that rate cut went straight to the shareholders of major banks, which isn’t likely to have been part of the aim of the central bank. Tough job, that central banker business, don’t you think? You try to give the economy a help-along and in doing so you open yourself up to all sorts of disagreement and claims of faulted decision-making. I certainly wouldn’t want to be trying to balance an entire economy and then having to justify just how this will impact that to all and sundry!

And from my Friday Musing point of view, a good part of the reasoning behind dropping rates from this point is based on the false premise that dropping rates will promote economic growth. Part of the logic is that debt costs remain low for high quality borrowers, or some such wording… Yet high quality borrowers are generally reducing their debt levels at the moment, in order to build reserves and prepare themselves for future rate rises or to build some cash to help with slower economic growth. So the conundrum is that higher quality borrowers aren’t the issue – it’s the next tier borrowers and the tier below them. Those folk generally aren’t seeing the benefits of lower rates. They often can’t even get finance because of the tighter lending standards. And it’s these folk who would be most likely to go out and spend some saved dollars to keep the economy moving. So the only real reason i can see for dropping rates is to keep the Australian dollar as low as possible.

RBA Interest Rates decisions are incredibly complex

Personally, i think Australia’s central bank does a fantastic job. They are prudent, cautious and yet somehow still manage to stay focused on growth. That’s a tough call. And the depth of thinking behind interest rates decisions is impressive. If you are a regular reader, you’d be familiar with my annoyance at “finite predictions”. In other words, people making calls on the future direction of this or that without making it clear just how big the range of alternative outcomes is. The public announcements around the Federal Budget come to mind. What a sloppy way to present information in a technologically empowered world. Anyway, back to the RBA’s latest interest rates decision…

The final component of the statement on monetary policy includes this fantastic little section that highlights where things could go wrong and where the statement may turn out to be incorrect…

“It is also worth considering the consequences that different assumptions and judgements might have on the forecasts and the possibility of events occurring that are not part of the central forecast. There continue to be a number of geopolitical and economic risks that could materialise in the global economy for which the consequences are difficult to predict. For example, there may be a larger-thanexpected increase in inflation in the United States, which could lead the Federal Reserve to tighten monetary policy by more than market participants expect. In that case, a range of financial prices are likely to respond, including the Australian dollar, which would be likely to depreciate. Relative to the constant exchange rate assumption that underlies the forecasts, this would imply a boost to domestic activity and a pick-up in tradable price inflation in Australia. Another key source of uncertainty for the central forecasts continues to be the outlook for the Chinese economy, the reaction of Chinese policymakers to slowing growth and the risks created by high and rising levels of debt. In turn, uncertainty about the outlook for China has implications for commodity demand and ultimately for the forecasts for Australia’s terms of trade. Domestically, there is considerable uncertainty about the degree of spare capacity in the labour market currently and over the forecast period, and the extent to which wage growth will pick up over the next few years. The underlying balance of demand and supply in the housing market are also difficult to project. Both of these raise uncertainty about the outlook for inflation and activity.”

michaels musings interest rates rba monetary decision making process angst

Decision-making can be an angst-filled process.

How i do love to see people admit where their recommendations and suggestions may turn out to be wrong. The financial planner in me finds that most reassuring.

So much for my musings. Remember that i am just sharing my thoughts and hopefully providing some background on ways of reading the spray of business and economic news you encounter in a normal week. Let me know if there’s a better way of achieving that aim and i’ll see what i can do.

Have a great weekend!


Remember the Great Disclaimer/s

  1. i’m not an economist.
  2. I’m not an analyst.
  3. I’m not an accountant and i’m not privy to the halls and boardrooms of power.
  4. i do probably have access to more data than you but there’s no reason to assume that my interpretation of that data is any better than anyone else’s and possibly not even better than yours.
  5. So don’t take anything i say as a recommendation nor as personal financial advice because the law says that would be a foolish thing to do and i’m legally obliged to tell you not to.
  6. And in the event that you do take any action on my musings, remember that it’s on your own research and determination if it’s appropriate because i’m just another internet voice, and i’m not making any personal recommendations through this portal.
  7. Ummm..
  8. Have i missed anything?
  9. Oh yes – and don’t do anything until you’ve read the paperwork and the fine print.
  10. And get professional advice.
  11. And be prudent.
  12. And look up the meaning of “caveat emptor”.


Further Information



Leave a Reply