Posted by The Fundamental Analyst on Mar 21st, 2009

Addressing the American Chamber of Commerce in a function today, CBA’s Chief Executive Floyd Norris has this to say:

“There’s no doubt that the toughest period in the Australian economy still lies ahead of us,” Mr Norris told an American Chamber of Commerce in Australia function on Tuesday.

Norris also went on to say that he couldn’t rule out a cut in the final dividend for this year. after ANZ and more recently NAB have said they will cut dividends by about 25%.

Amongst other things, Norris said that funding costs remain high and thus further interest rate cuts could not be guaranteed to be fully passed on to customers. In addition CBA is seeing a uptick in delinquent loans but that it was not yet significant.

There’s not much in Norris’ comments that should be surprising to anyone with their finger on the pulse. Rudd’s handout programs will do little more than cushion a deteriorating economy. As the government digests that reality in the second half of this calendar year, there will be calls for Rudd stimulus mark III before the year is out.

Also out today, the RBA released the minutes of their March meeting laying out their reasons for leaving interest rates unchanged. As usual I don’t recommend you read the minutes unless you want to go to sleep so here is crux of it.

The question for policy was whether further stimulus should be added at this meeting, or whether, having reduced rates at each meeting since September, the Board should pause for a further evaluation of the situation. Members could see reasonable cases for both courses of action.

On balance, they judged that, having made a major change to monetary policy over the preceding several meetings in anticipation of weak economic conditions, the best course for this meeting was to leave the cash rate unchanged. Members believed this would leave adequate flexibility for policy at future meetings.

Clearly the RBA is leaving the door open, my expectation continues to be that the RBA will cut to at least 2% before we reach a cycle trough. The one bright spot the RBA mentioned and which has been reinforced by the data in recent months is housing activity, especially in the First Home Buyers segment.

In recent months there has been a bump in the dollar amount of lending finance for new and established dwellings whilst finance for investment properties has fallen back to levels last seen in November 2002. The RBA commented that:

In a sign of increased demand for housing, patterns of housing finance indicated an increase in housing loan approvals of about 10 per cent over the past few months, partly spurred by the increased incentives for first home buyers to enter the market. However, credit growth had remained low as borrowers had evidently taken advantage of the extra cash flows created by lower lending interest rates to increase debt repayments.

Further signs of an increased level of activity in the secondary housing market were significant rises in auction clearance rates in both Sydney and Melbourne in February, and a component of the Westpac-Melbourne Institute consumer sentiment survey indicated that current conditions were conducive to buying a dwelling.

Increasingly we hear calls from those in the real estate industry that home buyers should get in now while interest rates are near historic lows, clearly some are listening to that call. However I can’t help think that some buyers are being sold a lemon.

Rather than a recovering I believe the housing industry is only being propped up by the FHB grant, handouts from Rudd the redistributor and a false sense of urgency that buyers need to take advantage of low interest rates before inflation kicks in and drives rates higher.

My position all along has been that inflation was not and will not be a problem in the medium term, that deflation is and will continue to be the dominant theme as the global economy continues to de-leverage. Most, including me, aren’t old enough to remember that the last time the US 10 year treasury fell below 3% it stayed there for 23 years. That is not a forecast of the future but a reminder of the past. Of course that 23 year period kikced off with the Great Depression, a time when the Federal Reserve tightened monetary policy, the complete opposite of what the Fed is doing today.

So whilst many are quick to pile on the inflation bandwagon, I would urge you to take a look in the opposite direction. It will be interesting to see if the increase in the FHB grant is extended beyond June and to what extent the Housing market can continue to hold up in the face of a deteriorating economy. Lower interest rates are here to stay for some time in my humble opinion and that could lead to more than a few cases of buyers remorse in the next 12 months or so.