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Ben Kingsley Blog post by Ben Kingsley

RBA Rate Decision – May 2018

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Today Governor Lowe and the Board met and they kept the cash rate on hold for a 21st consecutive month. So we haven’t seen a change to the cash rate since August 2016.

So let’s take a look at what’s happening in the positive side of the economy.

Firstly, let’s look at business confidence. Business confidence is sitting really high at the moment, and the forward projections and outlook for that is also very, very positive. Now that’s resulting in business investment in the non-mining sector. So, it basically means that all of those businesses that we wanted to be investing into their business, because investment also means jobs. Also, globally, we’re seeing the overall global economy moving quite well. We did see a few dark clouds around trade wars, but we’re starting to see some of those pressures start to ease off a little bit — I think that is sensible. We’re seeing unemployment — or employment itself — sitting at around 5.5%. Broadly speaking, that’s pretty good. So they’re the positive news stories around how the economy is moving forward.

But that’s not enough for the RBA to be moving the cash rate. In fact, we still have challenges in the economy around our inflation — it’s still not high enough. It’s still not in that 2 – 3% range that the RBA is looking for to give them some confidence to move on the cash rate.We are also seeing the correction in the property market. We’re starting to see property prices in Sydney and Melbourne starting to flatten — lower growth and, in some cases, it has declined in some markets as well.

We’re also starting to see the credit squeeze. Obviously all of the APRA macroprudential changes are still biting — so we’re seeing a tightening credit policy —which means that borrowers aren’t being able to access credit at the retail/consumer level as easily as we have in the past. So they are some of the reasons why the economy’s not moving. Because we then relate this to consumer confidence. And, consumer confidence… retail spending is sluggish at best. Still some positive numbers there, but still not giving us enough confidence to move the cash rate. So that’s the reason why the Reserve Bank has kept the cash rate on hold.

I want to take a bit more of a riskier step — and take a step outside what most people are talking about at the moment — and that is cost of funding.

I’m taking an early call on this — but there’s a few things that are happening around cost of funding, which is going to put pressure on banks, passing on that cost to consumers. What I’m talking about here is, firstly, the ten-year US bond yield. That has moved above 3% for the first time in over three years. Now that has been a combination of a couple of things: rising rates in the US, but also, potentially, these trade wars that we saw between US and China. Again, I mentioned earlier that they are starting to cool down a little bit; but that has pushed that bond yield high. Now what does that mean?

That basically means that wholesale funds we might get offshore — in Australia we get around 70% of our funds domestically through deposits, and then we on-lend that through the banks. But some of those wholesale funds for our second-tier lenders is going to come from offshore. Now that these cost of funds getting higher, it obviously means that what banks get their money for and what they lend it out for — that’s their margin — it could be squeezing this margin. Now, no right banker in their right mind — right in the middle of this Royal Commission — are going to do an out of cycle rate rise.

It would just be PR suicide; the brand damage would be terrible. But it is going to happen at some time into the future — those cost of funds are going to bite into margins.

In addition to that, we’ve seen some of the shocking revelations around the Royal Commission and that is going to cause greater compliance for banks. There also may be provisioning of fines that may be imposed on some of these breaches that we’ve seen. We’re also seeing early stages of class actions against some of those banks in regards to their practices. So that is all a big cost — ultimately, the bank is going to have to fund that. Now, their shareholders are likely going to be very disappointed in that and the shareholders are going to want to see a return at some point into the future, so with all of this pressure that comes from something like the Royal Commission, ultimately, someone has to pay. Now, whether that’s going to be the shareholder, the wages inside the bank or, ultimately, the consumer. One’s going to argue that it’s going to be all three of those things.

But, make no mistake, the cost of money is going to get higher and that’s going to be passed onto consumers.

That’s why, here at Empower Wealth, we’ve always talked about this — making sure you set your cash flow models to a long term interest rate; not this very, very low interest rate that we’ve got at the moment. So 7.25% has always been our bench mark, in terms of making sure you can afford the lending you’re engaged in as part of your wealth creation strategies. So just keep that in mind and make sure you’re also building that war-chest and buffer up, make sure you’ve got that offset account working for you, and you’ve got your living and lifestyle, and you’re using the Money SMARTS System.

If you want to learn more about the Money SMARTS System and download our little fact sheet than click the link below because that will give you more information around that. But this is a changing environment. So, even though cash rate might be on hold for the longer term, there’s no doubt that there’s going to be some movement around the cost of funding, and that’s ultimately going to hit the retail borrower, certainly the business borrower, into the future. Thanks for watching.

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