A surprise Federal Election result was seen as a positive for the Australian share market. The All Ordinaries index gained by 1.1% in May to close the month at 6,491.8 points. The Australian Dollar fell by 1.6% in the month, with 1 Australian Dollar currently buying 69.36 US cents.
The Reserve Bank of Australia (RBA) board kept the official Cash Rate on hold at 1.50% per annum in May, however, now over 80% of economists expect the RBA board to cut interest rates following their board meeting on Tuesday this week.
Increased trade tensions saw global share markets retreat quite sharply. For the month of April, the United States Dow Jones index fell by 6.7%, the London FTSE fell by 3.5%, the Japan Nikkei 225 fell by 7.4% and the Hong Kong Hang Seng Index fell by 9.4%.
The trade tensions relate once again to the United States and China failing to negotiate an agreement on free trade. However, late on Friday evening (our time) President Trump also threatened to impose tariffs on all United States' imports from Mexico – to pressure Mexico to stop the flow of migrants across the border.
It remains to be seen whether the latest threat will eventuate to tariffs. Nevertheless, investors are very nervous about the impact that tariffs will have on the United States' consumer, and by extension, the ability for the United States' economy to continue its economic growth trend.
Closer to home, with the majority of observers expecting that the RBA will cut interest rates this Tuesday, it is worth assessing the rationale of such a decision. The chart below highlights the likely key concern of the RBA board.
Source: RBA Chart Pack
As shown above, household debt has shown remarkable growth since the early 1990’s, before flattening through the Global Financial Crisis, only to grow rapidly over the last decade.
Importantly, the growth in Australian household debt over the last decade comes in a period of time whereby the RBA cash rate has fallen from over 7% per annum to 1.50% per annum currently (and expected to fall further). That is nearly an 80% reduction in the cost of funds.
Of key concern to the RBA Board would be the recent sharp decline in housing prices. The cause of this decline is largely attributable to tougher borrowing conditions, as banks place more scrutiny on loan applications following the Banking Royal Commission.
Ironically, to stimulate the provision of mortgages to borrowers, the Australian Prudential and Regulatory Authority (APRA) recently announced that they would be reducing the “assessment rate” that banks use to assess serviceability of new loans.
It must be said that if APRA has had to change regulations in an effort to stimulate liquidity in the mortgage market, then perhaps some of the remarks made by Commissioner Kenneth Hayne, while ideologically sound, didn’t consider the broader economic ramifications.
In this regard, I note that the construction and retail sector (both of which are heavily reliant on growth from the housing market) account for more than 1 in every 5th person employed in the country! If you throw in financial services (i.e. bank employees), then the figure increases even higher.
With such a reliance on the housing market for the economy, it is no wonder that the RBA board are considering cutting rates. The issue will be how and when they will ever be in a position to increase interest rates (given the level of Australian household debt).
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This article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation and investment objectives.