Now For A Chilly Winter Of Discontent As Rba's Rate Policy Thaws Too Slowly

The Age

Friday May 2, 2008

Ron Woods - Dr Ron Woods is founder of Econoclast.com.au. He has worked for many years in financial markets

The Reserve's rate rises amount to overkill, and building approvals prove it, writes Ron Woods.

IF YOU have ever applied to your local council for a building permit (especially in the eastern states), you will know it can take many months for an approval.

And with all the compulsory extra reports from architects, energy rating engineers, environmental consultants and, in some cities, historians, it can be an extra couple of months from the time a decision to build or renovate is made until you get an approval. All up it may take three to six months.

The data for March shows approvals have been falling for five consecutive months, and peaked back in October. Now, given the delays before approval, we can say the decision to seek building permits likely peaked last autumn to early winter.

The number of building permits then was hardly buoyant - about the same level as 10 years earlier, when the population was a couple of million people fewer.

When the frosty weather returned last year, the domestic economy also started to cool. Since then it has only got frostier. The official cash rate was 6.25% (now it is 7.25%) and there had been eight rate rises (now 12), and where most people live in Australia (outside of the resources boom-related regions), economic activity was growing by a significantly slower pace than it had for many years (remember that's around the time the former government began to slide out of re-election potential). The lack of enough new housing contributed to higher housing and rent costs.

Together with higher petrol prices, the Reserve Bank began to misinterpret the consumer price index data as a sign of "inflation" and towards the end of last winter, in August, it started a new round of interest rate rises. With the economy already slowing, that policy raised the risk of overkill and we raised our investment "red flag" then (and it's still flying). Now we are just seeing the data that demonstrates this.

Yesterday's data also reminds us that "China", or the "terms of trade", will not save the domestic economy. While building approvals have been falling since October Australia-wide, in "resource-rich" Western Australia the trend number of private-sector houses has been falling for 25 months in a row.

While I know I go on about the mistakes the RBA makes by setting the official cash rate too far out of line with market rates (a too steep or too inverted yield curve such as we have now), it is crucial for investors.

You see, mistakes made by man (there is one woman on the RBA board) by ignoring the market, along with some bad (and sometimes good) luck, are what cause business cycles; and this creates investment opportunities.

The next step by the RBA will have to be significant rate cuts to try to reverse the impact of its failed policy but it may take another three or four months before that happens - perhaps longer. That means for the economy - which began to cool last year - this is likely to be a very long winter.

Dr Ron Woods is founder of Econoclast.com.au. He has worked for many years in financial markets.

© 2008 The Age

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