This week, we saw a further reduction in official interest rates from 1.00% to 0.75%.

Forecasters have already started predicting two more. We have discussed the herd mentality of economic forecasters in previous newsletters – look at the last data point and project forward.

I believe that the most recent interest rate reduction, designed to promote economic growth in light of slowing overseas growth, was a mistake. Let me explain some reasons why:

  • Savers – there is a large segment of the community that have savings. Their income will be reduced by interest rate reductions;
  • Limitations of econometric modelling – The RBA’s decisions rely on a team of economic forecasters and sophisticated modelling.  I doubt that these egg heads and their models cater for the six month disruption to the economy caused by elections (Victoria, NSW, Federal), the Banking Royal Commission, Christmas and general negative commentary in the period November, 2018 to May, 2019.  I believe that May / June economic results have been negatively impacted by the resulting uncertainty.  These issues were covered in a previous newsletter.  I also wonder how relevant past economic data is when we have record low (ie unprecedented) interest rates;
  • Practical complications – I don’t think negative interest rates are acceptable to the Australian population. Hence deposit rates can’t fall to fully reflect further interest rate reductions. Further reduction in interest rates are unlikely to be fully passed on;
  • Underlying Economic Conditions – I believe that if the one off disruptions caused in the period November, 2018 to May, 2019 are correctly allowed for, underlying economic growth is stronger than forecast. There are already early indications of this both anecdotally and in early statistics such as property prices.

 Alternative Solutions

If the goal is to stimulate the economy, I can think of a number of more practical solutions than reducing interest rates:

  • Credit policies are restrictive at present.  It doesn’t matter what the interest rate is if you can’t qualify for a loan. A careful review of the recent changes to lending criteria would be much more productive. There are early signs that this is occurring – but it should be accelerated;
  • Penalties for Investors – the policies that have increased interest rates for investors and pressured them away from interest only loans and towards principal and interest loans should be reconsidered. There have been some positive moves in this area already;
  • Deregulation – it goes without saying that careful deregulation will always stimulate activity. Examples in a property context would include streamlining applications for planning permits / development approvals; and
  • Confidence – Politicians and the media could do much to overcome the negative outlook by simply being more positive and confident about the outlook. Arguing about how bad the economy might be does not promote investment or economic activity.

Implications for Property Investors

If my views are correct, then there are a number of implications for property investors:

  • The forecasted future interest rate reductions may not occur. If this is right, it might be a good time to fix interest rates while the market expects future reductions;
  • The current interest rate reduction may over stimulate the property market – which means, combined with slightly less restrictive credit policies, we might see a short term rise in property prices that is stronger than predicted.

I present the above as an alternative to the mainstream media opinion. I can offer no guarantees that I am right. My intention is to give you an alternative perspective to consider and then to seek such advice as may be appropriate to your situation.

There are scenarios that may warrant interest rate reductions – for example a deterioration of the current trade dispute between America and China. 

However, I believe that the Reserve Bank may have acted too hastily and that an interest rate reduction is not warranted at present.

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Lewis O’Brien