Cash Flow Advantage Blog

What is a Financial Bail-Out?

Fri, 11 May 2012 05:20:00 GMT

It is a slow day in a damp little Irish town. The rain is beating down harshly, and all the streets are deserted. Times are tough, everybody is in debt and everybody lives on credit.

...On this particular day a rich German tourist is driving through the town, stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night.

The owner gives him some room-keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher.

The butcher takes the €100 note and rushes down the street to repay his debt to the pig farmer. The pig farmer takes the €100 note and heads off to pay his bill at the supplier of animal feed and fuel.

The guy at the Farmers' Co-op takes the €100 note and runs to pay his drinks bill at the friendly neighbourhood pub. The pub owner slips the money along to the local prostitute drinking at the bar - who, in spite of facing hard times, has always gladly offered him her ‘services’ on credit.

The hooker then rushes over to the hotel and pays off her room bill to the hotel owner with the €100 note.

The hotel proprietor quietly replaces the €100 note back on the counter, so that the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, states that none of the rooms are satisfactory, picks up the €100 note, pockets it and leaves town.

...No one has produced anything. No one has earned anything. However, the whole town is now out of debt and looking to the future with a lot more optimism.

And that, dear ladies and gentlemen, is how a basic financial bailout package works!

RBA leaves door open for further rate cuts.

Wed, 09 May 2012 01:36:00 GMT

RBA Statement on Monetary Policy

The Reserve Bank has signalled that further interest rate cuts are a possibility. The downgraded its near-term forecasts and inflation is now expected to remain at the low end of the 2-3 per cent target band.
The key assumption around the low inflation outlook rests on a further easing in labour costs or an improvement in productivity. Clearly the focus is now on cost pressures rather than prices and they will be watched closely in determining inflation views.
The biggest risk to global growth remains the ongoing sovereign debt crisis in Europe. Annual GDP growth forecasts in December 2012 have been cut to the bottom end of the 3.0-3.5 per cent range. Underlying inflation is tipped to ease to 2.0 per cent in December 2012, down from 2.50 per cent
The central bank noted the widening gap between bank funding costs and the cash rate over the past year – a key reason behind the recent super-sized rate cut.
The Reserve Bank is increasing its focus on the weakness in housing activity. The near-term outlook for residential building activity has been revised lower however the longer-term fundamentals for housing remain sound. High rental yields, population growth, lower purchase costs and pent-up demand should support a pickup in mid-term activity.

What does it all mean?

What a change three months can make. The Reserve Bank has acknowledged the near term weakness in the domestic economy. Near term economic growth forecasts have been downgraded substantially while inflation is now expected to hold at the low end of the 2-3 per cent target band over the forecasts period. In short the door remains open for another rate cut within the next three months.
Interestingly the central bank has not highlighted much in the way of upside risks to growth forecasts. Rather the Reserve Bank goes one step further indicating a number of downside risks. The “sovereign debt problems in Europe” remain the biggest risk to global growth forecasts followed by the impact of “persistently high oil prices”.
The Reserve Bank has shifted its mid and longer term forecasts to broad ranges rather than specific forecasts. And while the shift to a growth band is fine, the magnitude of the range leaves something to be desired. The 2.5- 3.5 per cent growth forecast for December 2013 hardly provides any clarity on where growth is likely to be – in other words growth could be below, at or above trend “normal” rates. It is a similar story on the inflation front and effectively means that the longer term forecasts are less useful in gauging the Reserve Bank’s view on how the economy will perform. What is clear is that over time growth is expected to pick up steam and the optimism that the Reserve Bank has shown in its longer term forecasts is largely due to the anticipated pickup in business investment over the coming year– particularly mining. In fact the Reserve Bank has revised higher mining investment since the previous set of forecasts citing that “information from liaison indicates that some projects previously considered only possible now look more likely to go ahead than had been previously assumed, and that work on some other projects is progressing at least as fast as was expected.”
The strength in business spending plans is driven by the mining sector and will vary vastly across the states. In fact the clear driver of growth is expected to be Western Australia and Queensland in line with the view portrayed in latest publication of CommSec’s State of the States report
Interestingly the Reserve Bank has provided more clarity around bank funding costs. The Reserve Bank pointed out that funding costs relative to the cash rate are “estimated to have increased by about 0.2 per cent since mid-2011”. Clearly the super-sized rate cut provided last week was in part due to the narrowing of bank margins.
Looking forward, the door has been left open for further rate cuts; however the focus on inflation has now shifted from prices to cost pressures. The Reserve Bank made the clear distinction of the subdued nature of import prices compared with the more stubborn domestic cost pressures. The Reserve Bank will focus more predominantly on wage costs and labour productivity. Subdued wage costs and/or an improvement in productivity will ensure that the Reserve Bank has scope to comfortably cut rates further in coming months, if it is deemed necessary to stimulate activity. CommSec is pencilling in a quarter per cent rate cut in August.

What is the importance of the economic data?

The Reserve Bank releases its Statement on Monetary Policy each quarter. The Statement is the Reserve Bank’s assessment of economic and financial conditions and also contains the latest inflation views. The Statement is crucial is assessing the short-term outlook for interest rates

What are the implications for interest rates and investors?

Inflation is not expected to be a major concern in the over the medium term, with underlying inflation expected to remain within the target band over the forecast period. And as such the Reserve Bank has the option of moving to more accommodative policy in the next few months. CommSec expects a further rate cut in August particularly given the downside risks to global growth – with a strong focus on Europe.

Savanth Sebastian, Economist, CommSec

RBA focuses on shifting rates to a "normal" setting

Wed, 09 May 2012 01:28:00 GMT

RBA Board minutes

Downside risks to global economy prompted Reserve Bank to cut interest rates: Minutes of the last Reserve Bank Board meeting confirm that policymakers were concerned about the strength of the global economy. 'It was likely that economic conditions in Europe would weaken further over the period ahead... The sovereign debt problems in the euro area posed the most significant risk to the growth outlook'.Given the threats to the global economy the Reserve Bank was focused on getting interest rates back to a more normal setting. 'Financial conditions had already been easing somewhat, with a range of lending rates edging down over the past couple of months. Nonetheless, with overall credit growth remaining low, financial conditions on balance appeared to remain somewhat tighter than normal'.

What does it all mean?

Well it was hardly a surprise that there wasn't anything significantly new in the minutes of the last Reserve Bank Board meeting. Especially considering that since the rate cut and the accompanying statement, we have had the release of the Statement on Monetary Policy and also a speech by Reserve Bank Assistant Governor Lowe. If anything the minutes tend to confirm the view portrayed on November 4, when the Reserve Bank released its latest growth and inflation forecasts.
It is clear that Board members have certainly become more concerned about the global economic outlook, focusing on heightened 'risks to the global economy'
The European debt crisis dominated discussion and seems to be the key factor in the more flexible stance by policy makers when it comes to interest rates. Inflation is well contained and the Reserve Bank is focussed on a shift to more 'normal' financial conditions. At present the variable mortgage rate is still above 'normal' and if the risks to growth remain further rate cuts are likely.
Interestingly the Reserve Bank spent time discussing the multi speed nature of the domestic economy. In fact the central banks expected mining investment to increase to around 7 per cent of GDP by 2013/14, while the non-mining sector was expected to grow below trend.
Policymakers did highlight the importance and vagaries of the weather in defining the near term growth story. In fact the recovery in coal exports continued to be slower than the central bank had expected and a growing risk of a wetter than usual summer, could further delay the recovery in coal production.
Overall, the Reserve Bank Board minutes paint a mixed picture of the Australian economy. The mining sector continues to dominate the growth outlook with a strong pipeline of investment, however conditions remained weak in the manufacturing, construction, wholesale and retail sectors. In addition Board members noted the softer housing market conditions. With all manner of diverging trends, and downsides risks to the global economy Board members don't appear to be entirely comfortable at present, and as such further rate cuts are likely.

What is the importance of the economic data?

The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.

What are the implications for interest rates and investors?

The lack of momentum in the domestic economy and the heightened risk of further weakness in the global economy certainly adds to the chance of a rate cut in coming months. The Reserve Bank Board seems focussed on shifting to a more neutral setting and given that the variable mortgage rate is still above neutral, a further rate cut is likely. The timing of the rate cut will depend on the volatility in Europe.

Source Savanth Sebastian, Economist, CommSec

Downbeat RBA slashes growth forecasts

Fri, 04 Nov 2011 03:56:00 GMT

RBA Statement on Monetary Policy

The Reserve Bank has signalled that further interest rate cuts are a possibility, especially given that its previous forecasts for growth have now been downgraded, and inflation is now expected to remain within the 2-3 per cent target band.
The RBA has warned that risks are weighted to the downside. Annual GDP growth forecasts in June 2012 have been cut from 4.5 per cent to 4.0 per cent. Underlying inflation is tipped to ease to 2.5 per cent in June 2012, down from 3.0 per cent
Given that interest rates are at the high end of the normal range there is a high chance of an additional rate cut at the February board meeting. However any further rate cuts will largely be dependent on Europe. “The Bank's central scenario continues to be one in which the European authorities do enough to avert a disaster, but are not able to avoid periodic bouts of considerable uncertainty”.
The Reserve Banks central forecast assumes interest rates are unchanged over the forecasts period but given “A materialisation of the downside risks would likely be very disruptive for Europe and could result in a deep recession” it may result in the Reserve Bank cutting rates earlier than anticipated.

What does it all mean?

What a change three months make. The mood and tone of the Reserve Bank has changed from one of optimism to considerably more downbeat. Economic growth forecasts have been downgraded substantially while inflation is now expected to hold comfortably within the 2-3 per cent target band over the forecasts period.
Interestingly the central bank has not highlighted much in the way of upside risks to growth forecasts. Rather the Reserve Bank goes one step further indicating the heightened downside risks to forecasts. The weakness in the domestic economy, slowdown in advanced economies and the threat that the European sovereign debt crisis gathers pace and adds to serious market volatility.
The Reserve Bank is clearly focussing a lot more attention on global conditions, particularly given the concerns surrounding Europe. In fact any further rate cut is likely to be as a result of the volatility in Europe. It is important to point out that the longer it takes to find a solution to the European debt crisis the more heightened the risks are for the global economy. In addition a further rate cut would help to shore up domestic confidence and ensure that monetary policy move to a more neutral setting.

Source Savanth Sebastian, Economist, CommSec

First interest rate cut in 31 months

Tue, 01 Nov 2011 05:39:00 GMT

Reserve Bank Board meeting

The Reserve Bank Board has cut the cash rate for the first time in 31 months. The cash rate was trimmed by 25 basis points (quarter of a percent) to an 18-month low of 4.50 per cent. The next meeting is on December 6 2011.
In response to lower-than-expected inflation, the Reserve Bank concluded that there was scope to ease financial conditions. If passed on by banks, repayments on a $300,000 mortgage will fall by $49.10 a month.

What does it all mean?

This is clearly the best news that many people have had in quite a while. The past year has seen the worst floods and cyclones in a generation, a European debt crisis, rising power and water bills and a rash of industrial disputes. So a rate cut will be warmly greeted by consumers and businesses alike. We are pleased that the Reserve Bank rejected its inherent conservatism, listened to the concerns of Australians, and delivered an early Christmas present.
It is important to stress that the Reserve Bank is cutting rates from a position of strength, rather than weakness. The RBA can cut rates simply because inflation is under control, inflation is expected to remain under control and because financial conditions were a little too tight given the favourable position of inflation.
Effectively the Reserve Bank has admitted that it got it wrong. In August the Reserve Bank was set to hike rates. But it has become abundantly clear that inflation was under control and financial conditions were tighter than necessary.
Looking across the Four Financial Indicators (FFI) over the past month, it is clear that financial conditions have tightened. Dwelling prices continue to fall, the Australian dollar rose by US10 cents and 3-year swap rates have lifted almost 50 basis points. However credit growth lifted modestly over the past month. Overall, if the Reserve Bank hadn’t cut rates, consumers and businesses would have experiencing more challenging conditions.
While rates have been cut, no one should expect a follow-up move any time soon. This rate cut may be similar to the reduction made in December 2008 – the only interest rate changed delivered in a 27-month period. Certainly the November rate hike of last year was the only rate change delivered in a 17-month period, so the Reserve Bank isn’t averse to remaining on the interest rate sidelines for an extended period.
The Reserve Bank has signalled that it is more comfortable with economic conditions. The global economy has softened, the terms of trade has peaked and “inflation is likely to be consistent with the 2–3 per cent target in 2012 and 2013.”
The Reserve Bank has now moved back to a more neutral stance – that suggests rates could move either way in coming months. If rates are moving anywhere in the short term, clearly it’s down, rather than up.

Interest rate decision and past cycles

The Reserve Bank Board has cut the cash rate for the first time since April 2009 – the first time in 31 months. The cash rate has been reduced by 25 basis points to 4.50 per cent. The Reserve Bank had previously lifted rates seven times from October 2009 to November 2010 – a total of 1.75 percentage points, from 3.00 per cent to 4.75 per cent. Before today’s move, there had been only one rate hike in the past 17 months.
In the last rate-cutting cycle the cash rate fell to a low of 3.00 per cent in April 2009. In the previous rate-cutting cycle the cash rate fell to 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
The Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.80 per cent, well above the long-term average or “normal” rate of 7.15 per cent.
Since hitting lows of 4.00 per cent on October 4, 3-year swap rates have lifted to 4.41 per cent.

What are the implications of today’s decision?

For a more detailed explanation of the Reserve Bank’s decision, attention will now shift to the Statement on Monetary Policy, to be released on Friday. This report will contain the Reserve Bank’s latest forecasts on economic growth and inflation.
Investors will need to carefully consider the implications of the rate cut. If banks pass the full rate cut on to borrowers, they are also likely to pass it on to savers in terms of lower term deposit rates. Dividend yields on bank stocks remain attractive, holding near 6.50 per cent, while the property market will receive a boost from the latest rate cut.
The rate cut is especially good news for the beleaguered retail and housing sectors. But even tourism and export sectors receive a boost as the rate cut keeps a cap on the Aussie dollar.

Source Craig James, Chief Economist, CommSec

Reserve Bank employs a ‘jawboning’ strategy

Mon, 08 Aug 2011 23:19:00 GMT

Reserve Bank Board meeting

The Reserve Bank Board has left the cash rate at 4.75 per cent for the ninth straight month (covering eight formal meetings) – the most stable period for rates in five years. The next meeting is on September 6 2011.
With that latest reading of inflation on the high side of expectations, the Reserve Bank wanted to send a clear message on interest rates. The RBA has made it clear that if rates were likely to move in any direction in coming months it would be up, not down.

What does it all mean?

In July, the Reserve Bank adopted a more “dovish” stance, that is, it acknowledged the weaker outlook for the economy and inflation. In the latest commentary the central bank has returned to its more traditional “hawkish” language so that it is clear to all and sundry that it isn’t considering rate cuts any time soon.
The Reserve Bank Board has carefully crafted the accompanying statement, making it clear that interest rate cuts aren’t on the agenda. But while the statement suggests that the Board considered whether further policy tightening was warranted at the latest meeting, this appears a case of jawboning. To have increased interest rates when a raft of indicators suggested that the economy was stalling would have been the definitive “courageous” decision. Rather the Reserve Bank hopes that its latest attempts at jawboning do the work for it, that is, people get the message the RBA is worried about inflation, preventing it from actually having to go down the route of lifting rates.
While the Reserve Bank has adopted a more “hawkish” stance in the latest statement, the slippage in domestic economic momentum is plain for all to see. Manufacturing and construction sectors are contracting, home prices have fallen for six months, housing borrowing is at 34-year lows, dwelling approvals and consumer sentiment are at two-year lows and employment growth is the weakest in 16 months.
The Reserve Bank also needs to be mindful about the slowdown in the international environment with the US government cutting spending at a time when the economy is losing valuable momentum.
The Reserve Bank has inserted a fresh, new paragraph dealing with overall financial conditions. The RBA says last year’s rate hike, lower credit growth, the high Australian dollar and falling asset prices all indicate that financial conditions are tighter than normal.
We believe that the current softness in the economy is more of a temporary situation than something more entrenched. While consumers are not spending, this largely amounts to a reluctance to spend rather than inability to spend. Unemployment remains low and wages continue to outpace prices. As such, we think it is more likely that the Reserve Bank will lift rates in the future, but not before November.

Interest rate decision and past cycles
The Reserve Bank Board has left the cash rate at 4.75 per cent for the ninth straight month. In October 2009 the cash rate stood at a 49-year low of 3.00 per cent. But then the RBA embarked on a process to remove the emergency stimulus, lifting the cash rate by a quarter of a percent in October, November and December 2009, and then in March, April, May and November 2010. There has been only one rate hike in the past 15 months.

In the last rate-cutting cycle the cash rate fell to a low of 4.25 percent in December 2001. In the two previous rate-cutting cycles, the cash rate fell to lows of 4.75 per cent.
In response to funding pressures, banks were forced to lift rates above the cash rate. As a result, the Reserve Bank now looks more closely at the variable housing rate to gauge how close rates are to “normal”. Currently the average bank variable housing rate stands at 7.80 per cent, well above the long-term average or “normal” rate of 7.15 per cent.
Financial market pricing suggests that there is a 54 per cent chance of a 25 basis point rate cut within the next twelve months. But most economists actually tip at least one rate hike over the coming year. Conditions can change quite quickly – a case in point being the last month when financial market views have flipped from rate cuts to rate hikes. CommSec currently factors in just one 25-basis point rate hike over the remainder of 2011 but this would require signs of stronger economic growth and higher inflation for the forecast to be validated.

What are the implications of today’s decision?

The focus now shifts to Statement on Monetary Policy on Friday. If the Reserve Bank feels that the community needs to be conditioned to expect higher rates in future, then it may start the “softening” up process with the commentary in the statement.

Source Craig James, Chief Economist, CommSec

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Fri, 11 Mar 2011 03:47:00 GMT

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