Why the RBA Will Cut Interest Rates More Than Most Think

Why do I now think the Reserve Bank of Australia (RBA) will cut the cash rate by a full half a percentage point next week, to 1.75%?

The answer is simple: the RBA has been playing games with the markets since the start of the year.

I was one of the few analysts who predicted that the RBA would cut the cash rate in February. Most of the mainstream analysts were caught short…they just didn’t see it coming.

Then, in March and April, the markets thought a rate cut was a near certainty. And I’ll admit, I was with them on that score. I had no doubt at all that the RBA would cut rates.

But they didn’t.

They decided they could wait for further ‘data’, to see how things would play out.

Well, based on the last GDP numbers in March, for the December quarter, things hadn’t gone so well.

As ABC News reported back in March:

Australian economic growth slowed in the final three months of last year and remains firmly below trend, according to official figures.

The Bureau of Statistics says Australia’s gross domestic product (GDP) increased by 0.5 per cent in the December quarter.

That took the annual rate GDP growth to 2.5 per cent, down from 2.7 per cent in the prior period.

You can bet your bottom dollar that the RBA has a hotline to the Australian Bureau of Statistics to get the latest update on GDP numbers.

Odds are that it’s not looking so great, especially after the slump in commodity prices.

Check this out for one heck of a chart:

Source: Reserve Bank of Australia

Click to enlarge

Last week the markets got all excited over an uptick in the iron ore price. They shouldn’t celebrate too soon. It looks as though that commodity index of prices is heading back towards the mean.

Of course, as you know, when a market crashes it rarely stops at a ‘fair price’. More often than not it keeps falling, so that it’s soon trading at a discount to a fair price.

That’s when the bargain hunters jump in to pick up stocks and commodities at cheap prices.

As my old pal Greg Canavan wrote in today’s Markets and Money:

That fact that the iron ore price sank nearly 5% yesterday will probably put a lid on the Aussie dollar’s gains for now. In my view, the recent iron ore price rally won’t last. In a few weeks or months at the most, we’ll be back down to new lows.

If Greg is right (and I suspect he will be), the commodity price index will wave goodbye to the ‘mean’ as it passes on down to a multi-year low.

Then there’s the issue of the Aussie dollar. It spiked higher over the past week for a couple of reasons. First, the apparent recovery in some commodity prices, and second because investors now feel less sure that the RBA will cut interest rates.

That brings us full circle to what we wrote at the top of this letter — the RBA has been playing games with the market, simply to show everyone who’s in charge.

The feeling that the RBA won’t cut interest rates also explains the stock slump over the past two days. On Wednesday, Aussie stocks fell more than 100 points. As I write today, the S&P/ASX 200 index is down another 76 points.

At the start of the week the market was within a hair’s breadth of hitting 6,000 points. Now it looks more like an ascent to the top of Mt Everest with a wall of snow fast approaching.

But the journey to 6,000 points has long felt like that. You can see on the chart below. The market gets there, and then falls back:

Source: Google Finance

Click to enlarge

Maybe this is how Sisyphus felt pushing that boulder up a hill.

If you know your Greek mythology, the Gods punished Sisyphus for being deceitful. His punishment was to roll a huge boulder to the top of a hill…only, when he had pushed it to the top, it rolled back down, forcing him to do it all over again, and again, for eternity.

Maybe the ‘Gods’ are punishing the Aussie market for being deceitful…deceiving investors into thinking that they should pile in to pay any old price for dividend stocks.

OK, that’s a stretch. It’s true that the RBA doesn’t want to ignite a crazy stock asset bubble. But it’s also true that it doesn’t want to see stocks crash either.

But most of all, it wants to make sure that you know the RBA is boss.

I’m prepared to be proven wrong on this, but in my view a cut by at least 0.25 percentage points is dead certain. In fact, I’m now convinced that if the RBA really wants to exert its authority, it will cut interest rates by 0.5 percentage points next week.

It’s the kind of ‘show off’ move the RBA board members would love to make. And everything is set-up nicely for them to do it — falling commodity prices, falling stocks, falling economic growth, rising government debt, and a high Aussie dollar.

What more could the RBA want? A 0.5 percentage point interest rate cut is coming…and it’s coming next Tuesday.

Sydney house prices expensive? Not by this measure…
Is there anything that could stop the RBA from cutting rates at all?

In the old days, you could have said rising house prices would stop them from cutting rates.

But now, what does it matter? House prices never go down. In fact, as Property Observer reports:

Sydney’s median house price now sits at $914,056 after 3.6% quarterly price growth according to Domain Group research…

House prices in Sydney increased by 16% in the year to March 2015, by far the strongest annual growth. In the same period, Melbourne prices increased by 6.6% to a median of $638,445.

There are no words to describe those numbers, there really aren’t.

At that rate of growth, Sydney will have a median house price over $1 million by the end of this year!

It’s hard to think of many other places that could be as expensive. But Sydney isn’t alone. According to the Guardian, by late last year, median house prices in London were £514,000. At the current exchange rate, that’s AU$991,895.

It’s even more expensive in New York. There, according to real estate website Trulia, the median sales price of New York City properties is US$1,270,000. That’s a touch under AU$1.6 million.

You can see the 10-year growth rate in median sales prices on the chart below:

Source: Trulia.com

Click to enlarge

(By the way, I’d suggest there was some sort of fiddling around with the numbers in 2002–2003, to account for the odd blip on the chart.)

So, Sydney is expensive. But is it now excessively expensive compared to other ‘international’ cities? It pains me to say it, but it doesn’t look like it is.

That’s why you shouldn’t expect the RBA to use high house prices as an excuse not to cut interest rates. Interest rates in the US and UK are much lower. That explains the high property prices.

Low interest rates benefit those who already own property. Low interest rates make the cost of money cheaper, so that folks can borrow more for less in interest costs.

In short, high house prices won’t stop the RBA cutting rates. Thanks to years of manipulation in the housing market, the RBA knows that it can’t create a ‘soft landing’ in house prices.

When Aussie house prices fall, it will be an almighty crash. So the RBA won’t do anything to cause that. Instead, they’ll try to do what all central banks do when faced with an expanding asset bubble — they’ll try to keep it going for as long as possible. Or at least until they’ve retired; then it’s someone else’s problem.

RBA to cut by 0.5 percentage points next week.

Kris Sayce,
Editor, Tactical Wealth

Editor’s Note: This article originally appeared in Port Phillip Insider, the insider’s eletter for subscribers to Port Phillip Publishing’s premium investment services.

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Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005. He is the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service, Markets & Money.

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