Reserve Bank of Australia Makes Tough Decision

Today at their monthly review of the status of all of the financial aspects of the Australian economy the Reserve Bank of Australia (RBA) made the call not to reduce the wholesale cost of money (i.e., reduce interest rates).

This was a very hard decision for the RBA. Retail spending is still at historic lows and the government has been prodding the RBA to go for a rate decrease to get people to stop saving and start spending. New house starts are at a 30 year low. However the RBA board members are very concerned that further rate decreases would heat up the property market and cause home prices to start to rise again. This is something they are paranoid about and desperately want to avoid for as long as they can.

In order for the property market to come down from the current toxic levels they are sitting at—where the average house costs about 5.5 times the average income—the RBA needs the housing market to remain flat for at least another three years while the average income catches up a bit more. While they will never (not in my lifetime anyway) get the average house price down to the ideal level of 2.5 to 3.0 times the average income they would like to see it get close to 4.5 times which means the average income needs to increase by about another 22 percent while house prices stay flat.

The comment by the RBA when announcing that rates were not being decreased “ … home owners should not take any future rate decreases for granted” gave a strong hint to the RBA’s thinking.

It is VERY unlikely they will be able to achieve the correction in property prices they would like because the pressure from many lobby groups to drop the interest rate are likely to increase significantly with every month that the RBA does not bring the rate down. Sooner or later they will have to give in to the pressure. Also if the European crisis starts to impact Australia much more then this is also going to force the RBA to bring the cash rate down.

Another thing that could go ‘wrong’ is for the Australian dollar to fall. The single biggest negative impact if the Australian dollar falls will be the corresponding increase in the price of petrol. If petrol goes up then everything goes up in some degree because everything uses petrol to dig it out, feed it, process it, or transport it. A 20 cent fall in the Australian dollar would result in about an 22 to 25 cent increase per litre in the cost of petrol.

Edit 7:30 p.m. >>>

I might just add that the interest rate my wife and I were paying on our first house was 11 percent, and the rate we were paying on our second house was 14.5 percent at one point. To me the current ‘end rate’ of around 7 percent sounds like a bargain.