Interest rate policies unsettling consumer confidence

Posted on 21/03/2008  

If the health of an economy is based on confidence, what can you make of the Reserve Bank of Australia's decision to fight inflation by yet again lifting interest rates in March 2008, in the middle of the most volatile equities market we've seen since 1991.

It was the 12th consecutive rise since May 2002, when cash rates rose 0.25% to 4.50%. Australian home buyers have had no interest rate relief since 2001, when rates were cut from 6.25% to 4.25% in a bid to stimulate the housing market.

Neither of your correspondents are economists, but years of on-the-job experience in the business sections of newspapers would suggest that most normal people would regard higher interest rates as inflationary. Your loan repayments rise, credit card repayments compound, while the desired impact of monetary policy (dampening down the economy, wages growth and consumer prices), is yet to kick in.

Inflation is said to be running at 3.0% and forecast to be higher than that in 2008. The major banks, faced with problems of their own - tightening access to funds, defaults and problem loans - have all jumped in and lifted their mortgage rates by more than the 0.25% hike in the cash rate.

With the exception of the smaller, more flexible credit unions, Australian financial institutions could soon be charging mortgage rates of 10%. This is the point at which psychologists will tell you most people are beset by the fear of making decisions. They could fight, but will more probably flee.

Little surprise then that the March 2008 Westpac-Melbourne Institute of Consumer Sentiment fell by 9.1% to 88.6% in March from 97.4% in February. The survey was taken after the RBA lifted official rates 0.25%, but the size of the decline in confidence surprised Westpac chief economist Bill Evans. The decline over the last three months was the sharpest since this index was formulated in 1975.

Evans says there were many other periods between 1975 and 2008 when the RBA lifted interest rates in consecutive months so there are other factors at play in regards to the big drop in confidence.

Perhaps it was the 23% fall in the Australian share market - the largest fall since 1990-1991 - or the shock-horror current affairs episodes about the price of fuel and groceries that contributed to the slump in confidence. Predictably, the confidence of those with mortgages fell by a greater amount (12.1%). Over the year mortgagee sentiment fell 31.5% against a 23.3% decline in the index overall.

"The results from this survey are very important," says Evans. "They indicate that the Reserve bank's last rate hike, combined with further independent moves from the mortgage lenders, may have finally slowed demand such that inflationary pressures will ease."

Pity our Kiwi cousins, then, grappling to repay mortgages on rates as high as 10.75%. While the New Zealand Reserve Bank is holding cash rates at a record 8.25%, the relentless monetary policy measures of recent years led to a slight drop in national housing prices (-0.7%) in 2007, according to the New Zealand Herald. Inflation has been running at 3.3% across the Tasman.

According to, Australia and New Zealand are significantly ahead of western markets in terms of lifting interest rates; ahead of the UK, Norway, the European Central Bank, Canada, the US and Japan, with the latter two appearing to be going counter to monetary policy in the South Pacific.

Hardly surprising then that New Zealand's housing market is softening and journalists there are starting to dust off their "mortgagee fire sale" headlines.

The Dominion Post reported on February 11 that all of New Zealand's major cities had reported a slowdown in house sales and the market was characterised by increasing mortgagee sales. New Zealand's Reserve Bank has lifted official cash rates 13 times since January 2004 and while there has been no increase since July 2007, economists there suspect another rise may be in the offing, even though the economy is clearly softening.

Last week the New Zealand Herald reported that the average New Zealand household's net worth fell $4,900 during the December 2007 quarter following an increase of $1,500 the previous quarter. The decline (the first in seven years) was attributed to the previously-mentioned fall in housing prices.

Across the other side of the Pacific, US Fed chairman Ben Bernanke is taking the opposite tack, slashing official interest rates in an attempt to stem a sharp decline in economic fortunes in the US. The March 18 cut (0.75%) took US rates to 2.25% and sparked a short-lived bear rally in Wall Street and Australian stocks.

This was the sixth such cut since September 2007, when the much-analysed sub-prime mortgage crisis began to emerge. Wall Street responded with its biggest one-day rise since 1990, but the very next day the market turned in a 293-point sell-off, with similar patterns following in Australia and other markets.

What does this have to do with Australia, though, the world's biggest quarry, its mineral resources feeding insatiable demand from China? Aren't we fireproof?

If you spend half an hour browsing British and US newspapers on the Internet, you will get a very different perspective on confidence. Many commentators now routinely use the word "Recession" and the more bearish ones bandy the word "Depression" around often enough to suggest they may be suffering from a lack of serotonin!

Do we inevitably have to go along with another boom/bust cycle with all of the angst and economic and social pain that implies?

My esteemed colleague Terry Ryder says in a report elsewhere on this website that the Reserve Bank's folly is to introduce consecutive interest rate rises, without waiting to see if the previous increase has worked its way through the system.

The RBA has tried this strategy 12 times in a row now and it clearly does not work. The dilemma is that the US Federal Reserve's tactic - cutting rates six times in seven months - does not appear to work either.

The next RBA meeting is on April 1 - in itself a scary sign. There are a few economists who expect another rate rise then -but more of the ones like Bill Evans (who has been around a while) think we will have a breather, with another rise tipped in May. Just what that will do to the clearly shattered confidence of Australian home owners and consumers is fairly easy to predict.


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