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What Will Force The RBA's Hand?

There was a time when homeowners and other property investors watched the RBA like a hawk. Each month they would nervously await the RBA’s decision on the cash rate.

Even a 0.25% cut meant a slither more breathing space for those living paycheck to paycheck. That is, once the banks finally passed the rate cut through.

And of course, any increase in the cash rate would see variable loan rates jacked up within hours.

On Tuesday, though, the RBA’s cash rate decision barely rated a mention. When the RBA announced it had again left rates unchanged — at 1.5% — the news almost went unnoticed.

I guess after such a long period without change — nineteen months and counting — you could expect people to become complacent. Plus, they figure they will certainly hear about it if there is a change.

While the current period without a rate change is the longest in RBA’s history, it certainly is not without precedent.

The cash rate went unchanged for 17 months back in 1994–6. And in 1997-98, 2002-03 and again in 2013–15, the cash rate didn’t budge for 15 months.

Plus, there have been plenty of times when the cash rate didn’t move for the better part of a year. It is just that when rates do move, it is usually part of a bigger cycle.

The following graph will be familiar to many. It’s the cash rate going back to 1990.

RBA cash rate

RBA cash rate 08-03-2018

Source: RBA
[Click to enlarge]

You can see the eye-wateringly high rates in early 1990. Back then, the RBA was trying to bring rampant consumption and inflation back under control.

Then RBA Governor, Bernie Fraser, noted in the first meeting of 1990 that money market rates had risen a full seven percent in the two years prior. In doing so, it had helped finally put a break on demand.

This enabled the RBA to cut rates by 0.5–1% to a target range of 17–17.50%. Almost incomprehensible compared to today’s rate.

Such aggressive monetary policy took the heat out of the economy. However, it also put a lot of businesses to the wall, with Australia going into a short but brutal recession.

The chart below again shows the cash rate. However, this time the chart only shows when the RBA cut rates. Each red dash represents a rate cut.

RBA cash rate cuts

RBA cash rate cuts 08-03-2018

Source: RBA
[Click to enlarge]

You can see the massive cuts throughout the early 1990s as the RBA tried to unwind the damage caused by such aggressive monetary policy.

You can also see the rapid cuts throughout 2008 and into 2009 (circled in blue) as the subprime disaster played out.

The first graph above shows that the overall trend for rates has been down for the last 27 years. But the second graph clearly shows that rate cuts happen in cycles — the clusters you see in the graph.

As the following graph also shows, rate increases move in clusters as well. However, you have to go all the way back to November 2010 for the last time the RBA increased rates (circled in blue).

RBA cash rate increases

RBA cash rate increases 08-03-2018

Source: RBA
[Click to enlarge]

What these graphs show is that when rates do move (either way), you can expect a number of similar moves soon after.

Because of that, it becomes as much about the timing of the first move, as it is the number of moves that follow.

With any talk about a rate move, the word ‘normalisation’ is not far away. That is, interest rates will eventually need to move back to ‘normal’ levels.

What is normal, though, is anyone’s guess. In 1990, 17.5% interest rates would have been above ‘normal’. And at 1.5%, today’s rate is below ‘normal’.

With such a broad range over a relatively short timeframe, working out what is normal surely must be subjective. Especially when the overall trend during that time is down.

My bet is that the next move will be up. There is nothing new in that, that’s what the market is expecting as well.

And much like the rest of the market, I don’t think there will be a move up this year. That means that the record run of flat rates looks set to continue.

However, what will change this view very quickly are the two factors that go hand in hand — wages and inflation. The RBA puts current low inflation down to ‘low growth in labour costs and strong competition in retailing’.

With the level of competition in retail, and in some cases deflationary pressure, it is hard to see what could cause a bump up in prices.

However, we need to keep a close eye on the unemployment rate. We will know that we have hit full employment when wages start to tick up.

In lean times, companies can retain key staff by paying them above the average. However, it’s when these same companies have to increase pay to retain the rest of their staff that wages — and inflation — will start to grow.

And this is what could force the RBA’s hand.

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