The Australian Economy's Addiction to Low Interest Rates

Before I start today’s Daily Reckoning, I want to give you a heads-up on a project my old mate Kris Sayce is undertaking. It’s called the Megatrend Master Series. What is it? Saycey isn’t giving much away, but he’s about as excited as I’ve ever seen him. It’s a free online series of publications that describe a looming investment megatrend. Click here for details.  

Well, here we go again. It’s the first Tuesday of the month, and you know what that means…it’s interest rate decision time for the Reserve Bank. Or rather, indecision time. Chances are nothing will change and the RBA will leave rates on hold at 2.5%…exactly where they’ve been since August 2013.

It generally takes 12–18 months for the full effect of an interest rate cut to pass through the system, and we’ve argued previously that most of the interest rate stimulus has already worked its way through the economy. Therefore, by the end of the year, calls for lower rates will grow louder. The junkies always needs more, and the Australian economy is addicted to easy money.

The rate cutting cycle got underway in November 2011 and petered out by August 2013. The RBA completed 80% of the rate cutting cycle by December 2012. That means by now, the vast majority of the stimulus has passed through the system.

Because Australia is an asset price and debt dependent economy, it also means that lower interest rates have already had their full effect on asset prices.

Take a look at the stock market, for example. The ASX 200 finished the financial year down nearly 50 points yesterday, or 0.9%. At around 5,400 points, it’s back where it was in late October/early November. That means the 12.35% rise in the market over the financial year all came in the first four months.

That in itself is not surprising. You take gains where you can get them and the market never delivers consistent monthly gains (except the S&P 500 and the Dow). My point here is that it was the rate cutting cycle that fuelled the gains.

It also helped that just prior to the start of the financial year the Australian stock market dropped by around 10% on concerns about a rapidly slowing China. Prior to that fall, the market was trading around 5,200 points. From the June 2013 high to today, stocks are up just 3.8%.

In other words, stocks have well and truly priced in the benefit of lower interest rates. In the absence of more rates cuts and/or a lower Australian dollar, you’re going to need to see earnings growth to give stocks another leg up from here. In the current environment, that’s going to be hard to achieve.

Regards,

Greg Canavan
for The Daily Reckoning Australia

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