Economy, Interest Rates

Reserve Bank of Australia Balancing Act

How will the Reserve Bank of Australia (RBA) balance the risk of a Sydney housing “bubble” against the otherwise sluggish Australian economy?

Yesterday (Monday 1st June, 2015) Treasury Secretary, John Fraser, declared that Sydney and parts of Melbourne were “unequivocally” a residential property bubble. He not only warned of a bubble but said there was unequivocal evidence that one existed. This is one of the strongest official warnings I’ve seen of a Sydney, and potentially partial Melbourne, property price bubble, however, it must be noted that this is not representative of the rest of Australia’s property market at the time of writing.

These comments follow comments by Greg Medcraft, the usually reserved chairman of the Australian Securities and Investments Commission (ASIC), a couple of weeks ago with warnings about a housing “bubble” in Sydney and to a lesser extent Melbourne.

The RBAs balancing act comes as all other economic signals indicate further rate cuts are more than just a possibility this year, however further cuts to the historic low interest rate may continue to fuel this Sydney residential housing “bubble” at a time when personal debt levels are also at very high levels again.

Interest rate changes are considered a “blunt” monetary policy instrument and therefore the RBA will have to consider the broader Australian economy, as they can’t laser target particular areas of the economy with interest rate changes.
 

So what will they do at today’s RBA rate meeting ??

I don’t believe the RBA will drop interest rates at todays June 2015 rates meeting however, given the following economic conditions I do believe we will see a further cut to the historic low rates before the end of 2015

  • the continuing sluggish Australian economy
  • sharp declines in resource-related capital expenditure
  • business investment in Australia contracting at its fastest rate in more than five years and no signs of improvement any time soon (The latest Australian Bureau of Statistics (ABS) Capital Expenditure Survey revealed total real capital expenditure fell by 4.4% and resource-related investment plunged nearly 14% compared with the same time last year. In addition, UBS chief economist Scott Haslem described the latest estimate of investment plans in Australia as “recessionary”, after being “bleak” last time)
  • continued increased unemployment levels which do not appear to have peaked as yet
  • subdued inflation figures and
  • an Australian dollar which although nowhere near prior highs (as I write this article the AUD is a little above 0.76 cents), is still likely to be higher than the RBAs preferred levels.

As always we don’t have a crystal ball however, I do strongly feel the RBA will leave rates on hold today and continue to monitor the effects of prior rate cuts and broader economic factors before the next move on the Australian interest rate.

Interest Rates

ASX RBA Rate Indicator

Reserve Bank of Australia

The RBA Rate Indicator shows market expectations of a change in the Official Cash Rate (OCR) set by the Reserve Bank of Australia (RBA). The indicator calculates a percentage probability of an RBA interest rate change based on the market determined prices in the ASX 30 Day Interbank Cash Rate Futures.

What is the RBA Rate Indicator saying today?

As at 9 January 2015, the ASX 30 Day Interbank Cash Rate Futures February 2015 contract was trading at 97.540, indicating an 18% expectation of an interest rate decrease to 2.25% at the next RBA Board meeting. There is also an 82% expectation of “No Change” at the next RBA Board meeting. Source: ASX
The next Official Cash Rate announcement will be on the 3rd of February 2015.

The table below highlights how market expectations of an interest rate decrease at the next RBA Board meeting (February 2015) has evolved in recent days prior to 9th January 2015.

Trading Day No Change Decrease to 2.25%
30 December 78% 22%
31 December 78% 22%
2 January 78% 22%
5 January 80% 20%
6 January 80% 20%
7 January 78% 22%
8 January 80% 20%
9 January 82% 18%

Source: ASX

Reserve Bank of Australia | ASX RBA Rate Indicator

Calculations for ASX Target Rate Tracker (Based on 30 Day Interbank Cash Rate Futures)

The expectation of a rate change by the RBA is calculated by taking into account the number of days the RBA Target Cash Rate is known versus the number of days in the month that it is unknown ie: the number of days before and after the RBA Board Meeting. By incorporating this time factor into a probability equation the following formula can be used to determine current market expectations on whether or not the RBA will change the Target Cash Rate:

rt * n b + {r(t + 1) p + rt(1 – p)} * na = X

Solve for p, where:

p = probability of rate change
X = current yield on 30 Day Interbank Cash Rate Futures
rt = current known Target Cash Rate (%)
r(t + 1) = expected new Target Cash Rate (%)
nb = fraction of month where target rate is known (ie: before RBA official rate announcement), eg: 2/31 for December 2003
na = fraction of month where target rate is unknown (ie: after RBA official rate announcement), eg: 29/31 for December 2003

Source: ASX