[transcript of video above]
Unemployment is otherwise unimportant to you, other than as a number, and I mean that. As I said, are you going to be selfish? You’ve also got to glaze over these things. Don’t get into the emotion of the stuff. When 4,000 people lose their job at Toyota or wherever it is, a Ford plant, I mean, that’s terrible for them at an individual level, but if you’re looking just simply how’s it going to affect me?
As I said, you’ve got to be a little bit selfish. You can’t get caught up in that stuff. That’s what newspapers do. We get caught up in it because we know we can play around and manipulate your emotions because we want to sell newspapers to you. That’s what we’re doing. We’re not actually trying to deliver good, valuable information for you to use selfishly to make a decision about your welfare.
You remember that. Don’t get caught up in that crap. Read it if you want to on a Saturday morning with a cup of coffee and you hang out, but just be able to take a step back and say, “Well, how does that affect me?” That’s how it affects you. 4,000 means not a lot when you have 600,000 turning over every month.
Inflation. We keep hearing about inflation. Inflation is a formula. It takes those numbers in those categories, there’s 11 categories of inflation, main categories of inflation. There’s 90 sub categories, but there’s 11 for all intents and purposes.
It comes out every quarter. The inflation number gets printed on the 26th, 27th, 28th of the month following the end of the quarter, so the 27th of July, following the June quarter, blah, blah, blah. Australian Bureau of Statistics prints it. They come out, they put in their 11 categories, but there’s a lot of categories they zip behind and they say, “What was the calculated price of clothing and shoes, footwear, as one category?”
The same categories I showed you on household consumption hasn’t gone up. If it’s gone up, that gets added up and they then put weighting against all of the various categories. Some categories are more important than others. They come out with a new CPI number, Consumer Price Index, change or inflation number. That’s just a number. Australian Bureau of Statistics prints the number.
Where it’s important is what does the Reserve Bank think about that number? What does the Reserve Bank want? Well, the Reserve Bank wants that inflation number to go between two and three percent annualized. They don’t want it to grow more than three percent, they don’t want it to grow less than two percent. They want it in the middle between two to three percent.
Why? Well, the 1996 Reserve Bank sat down, looked at their mandate, and said, “How are we going to deliver on our mandate of looking after unemployment in this country, looking after currency, and looking after the prosperity and welfare of all Australians? The decided in 1996 they would try and maintain an inflation rate of between two and three percent. 1996. We’re still looking at that two and three percent.
It may be the right number, bit may be the wrong number, but it doesn’t matter. That’s what it is. You and I are not going to change it. That’s their view, two to three percent. That’s where they want it. If it starts going above three percent, they crank the interest rates. If it goes below two percent, they reduce the interest rates. They do it over a 12 month period, so if the inflation number comes out for this quarter at three percent, that doesn’t bother them.
They’re interested in, is this developing into a trend? They’re interested in trends, 12 to 18 month trends. Now, the Reserve makes it very clear in their latest paper. What’s in the latest paper is this, currently inflation is right in the middle between two and three percent. It’s two and a half percent. Perfect, from their point of view. They have said, as a result of the Aussie dollar going down …
Now, they did predict it was going to go down to 82, 83. It’s at 90-something, so this may not be as big of a problem as they originally conceived, but as a result of it being in that area, and as a result of a number of other aberrations, they expect inflation to hit three percent in the end of the June quarter. They’re expecting in July the 26th, when the Australian Bureau of Statistics prints a number on inflation, that it’ll come out at around three percent annualized.
They said, “We’re not worried about that.” They, the Reserve Bank, have went on to say, “We expect,” we the Reserve Bank, “expect that to come back to two and a half percent by thought end of this calendar year.” Two and a half percent is perfect. What that means in the Reserve Bank’s mind, unless something major changes in the Reserve Bank’s mind, that means that they don’t need to increase interest rates or reduce interest rates. They don’t need to do anything.
They’ll stay the same, which means affordability will stay the same in the medium term, which means house prices should stay the same in the medium term, or go up, depending on where the population growth demand comes from, or how well that builds. Inflation is only important from the point of view of what the Reserve Bank wants it to be and why they want it to be there.
Inflation. That’s the 7th most important thing you need to know about. When you’re reading about it, you think, “Oh, yeah, they said something about inflation, what does that mean to me in terms of affordability, house prices, property prices, change in property prices, supply and demand?” It means it only has an importance in terms of what affect it’s going to have on interest rates.
Australia dollar. I keep hearing about it all the time. Australian dollar is not that important to any one of us unless you’re a trade exporter, or an importer, or you’re a trader in the dollar and trading currencies or something like that, which some of you may be for that matter. Generally speaking we keep hearing about it.
It’s important to the Reserve Bank, but the Australia dollar has an effect on export industries and therefore can have an effect on employment, or umemployment, can create umemployment. The Australia dollar can have an effect on the price of goods. It can have an effect on the difference between export and import prices.
In other words, if we’re exporting a whole lot of stuff and we’re getting a lot less for it, that’s a problem. That’s the only sort of real category that I see the Australia dollar with a currency a little bit out wide in terms of importance to us, when it comes to property prices. That’s the eighth most important thing I think you need to know.
Ninth one, ultimately interest rates. Interest rates, the Reserve Bank said this, this is not me, is the single most important factor in the affordability algorithm for property prices, obviously. Now, when it comes to doing a normal lender, when it comes to deciding how much we’re going to lend somebody, I’ll tell you what we do.
We look at your ability to service the debt. That’s called a debt servicing ratio, a net servicing ratio, there’s all sorts of formulas, but we use what they call an NSR. In making that assessment of your ability to service the debt, what we do is we take the prevailing interest rate. Now, our interest rate is set off effectively what the Reserve Bank rate is. That’s the lowest rate in the market, the Reserve Bank rate, the cash rate is the lowest rate in the market for the lowest risk environment.
None of us can invest at that rate because we can’t invest with the Reserve Bank. The Reserve Bank won’t take your money. The Reserve Bank is looking after the Australian government. That right there sets off every other interest rate in the market. If I’m lending to you at 5.5%, and Reserve Bank rates two and a half percent, that’s three percent premium, is the premium for risk I must charge you over and above the relative risk that the Reserve Bank would charge … I would charge the Reserve Bank, but if I was depositing with the Reserve Bank …
That’s the relativity. It’s a relativity argument and that’s sort of where it sits. Now, what’s important to understand, two and a half percent to five and a half percent is right around the money when it comes to standard variable rate, not discounted rate, but standard variable rate. It’s 300 basis points. That spread is quite important.
That spread is the highest it’s been since 2008, or 2007. In other words, the risk assessment between the Reserve Bank number and what retail number is, is the highest it’s every been, which is the reason why bank are making more money than they’ve ever made before. The reason why that is so high is because they haven’t bought everything. During the GFC, that’s why the banks make more profit than ever before, even though they’re books are growing at a slower rate than they’ve ever grown in the last 15 years.
by Mark Bouris
Video from Property Club Conference in 2014!