We are all now in the 1% club. And that is not necessarily a good thing. In this fortnights update we discuss the ultra-low rate environment and its influences on small business, and the tons of debt we have sitting around that might push property prices back up.
The steady decline
Since 1990 when the cash rate hit its peak of 18% it has been slowly but steadily falling till it hit 1% this week, from the first back to back monthly cuts in seven years.
Along this decline has been the dotcom crash at the start of the new millennium, a domestic recession and the Global Financial Crisis of 2008.
There is more evidence that busts similar to these are on the horizon rather than a boom.
This most recent cut is a signal from our central bankers that all is not well in our economy, and they clearly said that there are limits to how much cutting rates will do, the rest is in the hands of the government.
However, the RBA will do what they can and one of the key figures in its numbers game is unemployment.
They have said explicitly that they want to see the headline jobless rate at 4% or below. We are somewhere around 5% at the moment, so there is quite a bit of reduction to go before we get to their ideal number.
The issue with lowering the cash rate to achieve this outcome is that it relies on businesses to use the ‘extra’ funds they might save from lowered debt costs to invest in their business and hire people. The RBA is trying to change your mind to get back to work.
But when we look at how businesses are doing, particularly the roughly two million small to medium sized businesses, who employ around 4.8 million Australian workers, the situation is not great.
For instance, ever rising costs for energy, wages and rent are hindering growth, and many small businesses have debt to service, usually in the form of a business loan secured by a mortgage on their family home. Some of the debt might see a reduction in cost when attached to a residential mortgage or if it has a variable rate, but the differences will not add up to the cost of hiring a new staff member even on a part time basis.
Compounding this issue is that even if a business wanted to grow either by hiring people, buying more stock, buying new equipment, investing in marketing or needing working capital, access to credit has been a challenge. There are a lot of options out there to explore though.
So as Dr Lowe sits in 65 Martin Place waiting for the economic indicators and numbers to roll in and be analysed small businesses are doing it tough.
Cheap money
Even with the lowest cash rate ever on record and lower funding costs for lenders, according to recent figures released by the RBA housing credit growth was 3.7% over a year to May, which is the weakest growth since 1976.
This means that lenders, particularly the big four banks, have seen drastically different lending volumes than during the boom. And drastic in a bad way, as lending has hit its lowest in forty years.
Perhaps that is one reason why 3 of the big 4 didn’t pass on the full cut.
Notably, ANZ has, as in the past, seen a huge drop in its mortgage book over the first five months of the year of $3.2 billion. But were the only of the big 4 banks to pass on the full 25bps rate cut, however, they passed on only 18bps last month.
Most of those customers probably went up the road to a CBA branch, as contrary to this CBA’s mortgage book increased by a whopping $6.4 billion over the same time. Who also only passed on a 19bps reduction to borrowers from the July rate cut.
The low credit growth numbers mean that people have not been borrowing (either by choice or declined) as much as in the past and this correlates directly with the falling property prices we have seen in Sydney and elsewhere.
Now that money is as about as cheap it will get, will people start borrowing for property again?
Well there is definitely confidence back in the property market, and with property prices in Sydney showing the best result since middle 2017 we could say the downward slide in prices has ended, and they are probably at the start a gradual recovery.
According to Core Logic, Sydney recorded a 0.1 per cent increase result in June, which is the least worst, and only positive increase, result in a year of steady declines.
This marks a significant milestone in the direction of property prices. While we probably won’t have huge growth for the remainder of 2019 as prices will plateau and stabilise, this is the start of an uptick.
Ultimately this wave of cheap money will ease funding pressures for banks and lenders, but because of the increased costs they face, namely compliance costs, remediation bills, law cases, government-imposed capital costs and competition. All of which impact their bottom line, customers will not completely benefit. Actually, customers will likely be the ones paying for this in the end either through government bail outs like in the US, fees, or reduced value in shares (which you most definitely own in one way or another).
The reason the RBA wants to keep funding costs down for banks, which is partly done via the cash rate, is to encourage them to keep lending. As we have seen above, credit growth, that is to say the amount of new lending banks are doing, is significantly down. Low credit growth equals low economic activity.
However, we already have a ton, or more accurately trillions, of debt.
Australia has been riding a debt wave at least since the GFC and the average household has almost twice as much debt to their income. That is to say for each dollar the average household earns they owe almost two. Of course, many owe far more than that with the size of mortgages inflating along with house prices, especially in Sydney.
We have been splurging on cheap debt to fuel spending and price growth in assets classes like property has been a major repercussion.
It is very likely that all this new cheap money and low interest rates will push prices towards the 10% recovery needed for them to equal the peak in 2017.
The issue is we have to (eventually) pay off the debt, and now that money is even cheaper, and many people will borrow more, we are kicking the can, full of IOU’s, down the uncertain but certainly bumpy road.