Brakes On, But Were We Already Slowing?

Sydney Morning Herald

Wednesday February 6, 2008

Malcolm Maiden

THE debate about the wisdom of the Reserve Bank's decision to raise interest rates was underlined yesterday by a rush of coincidental news that suggested the bank's governor, Glenn Stevens, was applying the brakes to an economic vehicle already drifting into the slow lane.

From Adelaide came the news that after a decade of uncertainty oiled by government bribes, Mitsubishi had finallydecided to pull out of vehicle manufacturing in this country. The Australian Bureau of Statistics chipped in with news that building approvals sank by 16 per cent in December compared with November, a change four times more than expected. And the NAB reported that business confidence fell to a year low in the December quarter, as capacity utilisation and skills shortages remained at record highs.

The Reserve nevertheless maintained a hawkish stance, once again noting the conflicting forces of inflation and a global liquidity squeeze that is undermining global growth, and coming down in favour of further interest rate friction.

The opportunity to signal that an end to a rate rise cycle that has carried rates up from a low of 4.25 per cent in May 2002 and up by 1.5 percentage points since May 2006 was not grasped. The Reserve said it expected inflation growth to ease in 2009, but that was old news: more telling was its comment that demand needed to be reduced significantly, and that even after the latest rate rise it would need to "continue to evaluate whether the stance of policy will be sufficiently restrictive".

The quarter of a percentage rate rise is not going to send hordes of home owners to the wall. Two-thirds of Australians own a home, half of the owners have mortgages, and 0.7 per cent of Australian mortgage loans are subprime - that is, made to people with a credit default history - compared with about 15 per cent in the US, where the subprime crisis erupted.

According to Standard & Poor's, the percentage of Australian securitised home loans in arrears by 30 days or more fell to a two-year low in November, to 0.98 per cent, down from 1.04 per cent in October. The percentage of subprime mortgages in arrears was higher, at 12.55 per cent, but it was also down in the month, from 12.85 per cent in October.

The rate rise will instead do what it is intended to do: cramp business and consumer demand, by redirecting money from goods and services into debt service payments. The real question is whether a slowdown was already occurring, making this increase superfluous, or at least premature.

Yesterday's building approvals data was accompanied by news that retail sales growth slowed to 0.5 per cent in December from 0.8 per cent in November, and credit growth is already slowing, although the trend has been masked.

System-wide, credit expanded by 16.5 per cent in the year to December, up from 14.3 per cent a year earlier - but that was due to a rise in business credit growth from 15.8 per cent a year ago to 24.3 per cent in the year to December - and that increase in turn flowed not from increased business borrowing but from a shift in debt sourcing, away from the traumatised credit securities markets, and back to bank loans.

Housing credit growth has been slowing, from a 12-month rate of 13.6 per cent at the beginning of 2007 to 11.5 per cent by year-end. Personal credit growth rose from 12 per cent to 13 per cent over the same time, but that was down to a bull market margin loan binge that is now correcting itself. Banks report that credit card debt growth has also been easing.

Add to that the fact that the big Australian trading banks raised lending rates themselves by an average of 15 basis points in January to cover higher wholesale money costs, and as the Reserve observed yesterday, the global growth outlook has softened this year, as the liquidity squeeze that flowered in mid-2007 combines with a fierce US housing market downturn to infect economic growth.

The Reserve did not say so but on that front much now rests with the theory that the rest of the world, and China in particular, can sail on, even if the US economy treads water for a while. The decoupling theory is supported by statistics that show that China's 11 per cent growth clip is sourced more from domestic demand than exports to the US and elsewhere, and if it is wrong, all growth bets are off. The critical issue is what happens at the margin: economic growth of, say, 8 per cent a year in China would still be strong by normal measures, but the downshift from 11 per cent could produce a global shockwave.

Uncertainty abounds, in other words - and that raises interesting questions for cashed-up investors, who will see a rising interest rate trend as their friend.

The new cash yield benchmark is 7 per cent: BankWest was the first to offer it on deposits yesterday. And it is stacked up against a sharemarket that is yielding 4 per cent from dividends, or about 5 per cent including dividend franking credits.

The sharemarket must post capital gains to match cash, in other words, and it must also pay a risk premium, because companies are riskier. It is not unreasonable in a market as volatile as this to say that a 10 per cent-plus overall return from shares is needed this year to match cash, and the sharemarket is actually down by almost 9 per cent so far in 2008.

There are stocks that areexceptions. But stock-picking that depends on continued corporate earnings growth is not a compelling short term option when the Reserve Bank has set the cash return at 7 per cent and signalled it could go higher.

mmaiden@theage.com.au