Reserve Bank Keeps Its Powder Dry

As most everybody would be aware by now—well, everyone in Australia anyway—the Reserve Bank of Australia (RBA) did not lower the cash interest rate on Tuesday.

The sticky situation that the RBA now finds itself in after dropping the cash rate three or four times a year for the last five years or so, is that they are running out of breathing room. There is now only 1.5% of room until the rate hits zero.

I think this has kind of spooked some of the analysts at the RBA because all indications are that the economic woes of the world, and particularly those of Australia, are far from over. Some financial experts are even suggesting a return to the 'good times' is 15 to 20 years away.

The Australian federal government is more in debt than any federal government of Australia has ever been before, and they don't appear to have any viable workable plan to turn this situation around within the next 1o to 15 years. In fact, at this time, the debt burden is still increasing.

On top of this the household debt in Australia is also at all time highs.

Relative household debt has tripled in the last 25 years. A huge part of this is the mortgage debt being carried by households but our willingness to buy on credit has also contributed heavily.

Depending which numbers you choose to use (they are all pretty bleak), twenty five years ago the average mortgage took 18 percent (very close to a fifth) of the average household after tax income to service—despite the much higher mortgage interest rates then that were up in the low to mid teens. At one stage the interest rate got over 17 percent.

Today the monthly mortgage repayment on the average 30 year loan of $428,000 requires $2,043 to service which is a whopping 31 percent (almost a third) of the average household after tax income—at a time when the interest rates being paid are in the vicinity of a ridiculously low 4.0 percent.

If you took the average WA mortgage of $428,000 and worked it out over 30 years at 15 percent then the repayments would be close to a very scary $5,400. Even at 10 percent you are looking at $3,750.

This is all theoretical. It appears to me that very few households have a before-tax income close to the average of just over $100,000. Obviously I don't know many average households.

The key term in all of this is 'household'. Use of the term household presumably assumes two incomes. A primary and a secondary, usually, but not always, the hubbies income combined with the wife's income. Probably with the primary income being around $66,666 and the secondary income contributing the remaining $33,334.

Anyway, enough of that rambling.

The point is that the RBA only has 1.5 percent left to play with. Actually, as I seriously doubt they ever really want to hit the big zero, I suspect they only really have 1.0 percent of room to move downwards.

So my call on this is that the RBA will apply a lot more caution in dropping the rate any further in the future, and, also, they are likely to move the rate in smaller amounts—like maybe 10 basis points at a time instead of 25.

Yep. They need to keep that little bit of remaining powder dry 'just in case'.