At 2.35pm Last Friday, the RBA Became Irrelevant —
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At 2.35pm Last Friday, the RBA Became Irrelevant

In today’s Money Morning:…Aussie banks on a collision course with the RBA…reasons to be optimistic about the future…low inflation numbers are a fraud…a cost greater than losing money…timeless investing wisdom…

At 2.35pm Last Friday, the RBA Became Irrelevant

One of the supposed benefits of the Aussie market is that the Reserve Bank of Australia (RBA) can move interest rates and the retail banks will follow suit.

We’re sure you’ve heard mainstream commentators say, “Our economy will be fine because the RBA has plenty of room to move.”

So, when the RBA cuts interest rates to boost the economy, the banks cut rates… and when the RBA raises interest rates to slow the economy, the banks raise rates.

Or that’s how it worked until 2.35pm last Friday.

That’s when the world heard that ANZ Bank [ASX: ANZ] had lifted interest rates separately of the RBA. In a moment, we’ll explain how ANZ’s attempt at interest rate independence is nothing more than mistimed bravado that’s set to backfire.

Because it all but guarantees the end of huge bank profits. First…

88% of Economists Got it Wrong

It’s funny how quickly the market turns. Four days before the ANZ raised rates, 24 of 27 economists surveyed by Bloomberg News predicted the RBA would cut interest rates at its February meeting.

It was all set to be good news for variable rate borrowers. But when the RBA decided to do nothing, mainstream commentators were shocked. Especially when most of them had claimed a cut was certain.

But before borrowers could digest the news they found out their mortgage rates not only weren’t going down… they were about to head higher - 0.06% higher for ANZ customers and 0.1% higher for Commonwealth Bank [ASX: CBA] customers.

In one swift stroke the ANZ did what even the most ardent anti-central bankers could not do: it made the RBA’s interest rate setting role redundant.

They’ve cut the cord and perhaps the market’s fixation with the first Tuesday of each month is over (when the RBA sets its benchmark interest rate).

When you think about it, it’s not so surprising. We won’t say no-one cares about the U.S., Euro or U.K. interest rate level anymore. But it’s now an afterthought.

The Aussie central bank is just following the global trend.

That trend is where central banks lose control of their interest rate setting powers. Where their only influence is to resort to money printing.

The problem for the RBA is that unlike other major economies, they don’t yet have an excuse to print money. So, how can it stay relevant?

Setting the Scene for AussieMac

Assuming those at the RBA want to stay relevant. After all, people don’t join the RBA board because they want to be irrelevant. They join the board because they want to influence and change things. So, we wonder. Could one way of influencing and changing be to make direct investments in the Aussie housing market?

The Aussie government’s money managers, the Australian Office of Financial Management (AOFM) already owns $14.6 billion of residential mortgage-back securities (RMBS).

This is part of the program to increase competition in the Aussie mortgage market. Trouble is, it has been a total failure. The four major Aussie banks are more powerful than they’ve been for 30 years.

A tiny $14.6 billion won’t change anything. The reason is, because like most government programs, it targets the symptom not the cause (my old pal, Greg Canavan has more on this below).

But our guess is the government will do what most governments do. Rather than admit a program has failed because it was a bad idea, they’ll claim it hasn’t failed. They’ll claim it just needs more money.

(Think government healthcare, schools and law and order - all are failures, and yet they’re given ever larger amounts of taxpayer dollars every year.)

So our bet is we’ll hear more about government plans to set up an AussieMac (named after failed U.S. government-sponsored mortgage firms, Freddie Mac and Fannie Mae). This will involve the RBA and AOFM teaming up to expand the mortgage securitisation market.

The RBA will continue to go through the motions of setting the monthly cash rate. But rather than this having no effect on bank mortgage rates, they’ll use the RBA cash rate as the benchmark rate for the new AussieMac home loans.

In other words, if the RBA can’t influence the banks’ interest rates directly, it will try to do it indirectly. This could even mean targeting longer-term rates such as the 10-year bond, or even working with the AOFM to create a 25- or 30-year bond that can be the new benchmark for long-term fixed mortgage rates.

That’ll create a problem for the Aussie banks. Because in order to stay competitive and not lose customers to AussieMac, the big banks will have to keep rates lower than they otherwise would. That means squeezing margins… and lower profits.

Four to Sell

But until then, the ANZ Bank has showed the market the RBA is no longer in a position to influence and change. It means whatever the RBA does, the banks will thumb their noses and do their own thing.

Can we really expect the RBA to stand for that?

The banks think they’ve gained their independence and regained control of their own profit margins. They’re wrong.

The bankers forget the only reason they’ve clocked up whacking great profits for so many years is because governments have allowed them to. Once the government removes its privileges, it’s game over.

They should have asked their buddies in the U.S., U.K. and Europe what happens when banks lose privileges. Even multi-billion dollar bailouts won’t keep the banking ship from sinking. As the following chart shows of five big U.S. and European banks:

Click here to enlarge

Source: Google Finance

We wrote last week that Aussie banks are heading for years of stagnation. And those high dividends are a selling rather than a buying signal.

ANZ’s decision (rightly or wrongly) to distance its interest rate decisions from the RBA cash rate only confirms what we already knew…

Aussie banks think they’re invincible… And the bankers who run them think they’re geniuses deserving of million dollar pay packets. But in reality they’ve just benefited like all government-granted monopolies.

Yet that hasn’t stopped them thinking they don’t need the government. They think they can go it alone.

But it won’t be long before they realise that without government support, and taxpayer funded bailouts the Aussie banking system is no stronger than any other banking system… And therefore is doomed to fail.

Kris Sayce.

This article is contributed by Money Morning. Click Here to Subscribe to their free newsletter.


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