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Last month, when National Australia Bank issues its index of online retail sales for the year to May, it appeared even e-tailers were experiencing the effects of a broader retail recession, with the growth rate for online sales continuing the gradual slowdown experienced over the course of this year. The latest numbers, however, depict a significantly more positive mood.
It has been evident in the most recent round of annual results from bricks and mortar retailers that something happened quite late in the financial year, with quite discernible upticks in sales and profitability at the tail-end of an otherwise dismal year.
The most interesting results were the 4.6% fourth-quarter increase in Woolworths Big W discount department store business, which had been really struggling before that final three months, Target’s comparable store sales growth of 4.5% in that quarter and its Wesfarmers’ sibling Kmart’s 2.2% sales growth. It is the discount department store segment of the market where the retail recession had been most evident.
Today’s NAB online retail sales index showed that online sales growth, which had dropped from 19% year-on-year in March to 14% in May, picked up strongly in July, with year-on-year growth of about 25%. NAB chief economist Alan Oster commented that there had been notable growth, not just in online sales, but for traditional bricks and mortar retailers.
That’s consistent with what the Reserve Bank minutes of its board meeting earlier this month suggested, with the minutes recording that the board noted indications that consumer spending had retained some momentum in the June quarter.
With three 25 basis points cuts and one 50 basis point cut to official interest rates in 10 months it perhaps isn’t surprising that some level of stimulus is starting to flow through to household spending, although that may not be the primary reason for the pick-up in retail sales.
It was, of course, from the middle of May that the Gillard government started splashing vast amounts of cash around as part of its compensation of households for the introduction of the carbon tax. With gambling venues reporting an immediate and significant lift in sales consumers may well have treated those payments as windfalls and simply spent them.
If that were the case, the lift in sales that started in the last quarter of the retailers’ financial year and which, anecdotally at least, has continued into the new financial year could be a short-lived phenomenon.
There are, however, some broader and reasonably encouraging signs that some level of confidence has returned to consumers and businesses, with house prices stabilising and the demand for credit, which had been very subdued, showing signs of life. Maybe it’s because Europe and the continuing prospect of an implosion in Europe haven’t been front page news for some time.
The dive in commodity prices and the shelving of a number of mega mining projects that were on the drawing boards may have an impact on sentiment in the short term, although as that works through the terms of trade and the competition for resources within the domestic economy it might take some pressure off the non-resource sectors and states.
While traditional retailers would be gratified by even a sliver of extra spending in their stores, the increased scale of online spending – $11.7 billion in the year to July according to NAB – and its rising share of total retail sales should lead them to intensify their own efforts to build an online presence.
NAB says that online sales were equivalent to 5.3% of traditional retail spending in the year to July, up from 4.9% in January. Encouragingly for the bricks and mortar retailers pursuing "bricks and clicks" or "omni-channel" strategies, domestic e-tailers dominate the spending, with a 72% share, although NAB says there was a marked pick-up in international sales in July.
Myer’s Bernie Brookes has been saying that, despite their tardy entry to online retailing, the traditional bricks and mortar retail brands will eventually dominate online retailing and that the entrepreneurs that have built the sector so far have "had their day in the sun".
By this time next year we’ll not only know whether the pick-up in retail sales generally was a cash splash-inspired aberration, but it ought to be possible to assess whether the attempt by the bricks and mortar retailers to establish a meaningful online presence has gained any traction.
This article originally appeared on <a href="https://www.businessspectator.com.au/" target="_blank">Business Spectator</a>
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Retail sales and profitability pick up, but will it last?

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It says something about the astuteness of the Lowy family that the twin vehicle structure they created nearly two years ago is starting to deliver the benefits they envisaged.  While it took some time for the market to warm to the hiving off of half Westfield’s Australian shopping centres into a new Westfield Group-managed entity, this year both entities have significantly outperformed their A-REIT peers in terms of sharemarket performance, with Westfield Group up 30% and Westfield Retail up 26% against an index that is up 16%. The philosophy of the Lowys’ restructuring was to put some distance, but not too much, between their development and property-owning interests while releasing capital from the spin-off of Westfield Retail and lowering its own future capital intensity to improve its returns on equity. It also gave investors purer choices of the types of Westfield exposure they were most interested in. Earlier this year they effectively extended the concept to their US portfolio by selling a 45% interest in a portfolio of 12 centres in the US to Canada Pension Plan Investment Board and separately selling 12 non-core centres for $1.4 billion. The $US2.1 billion US deal released about $US1.8 billion of net cash and again leveraged the returns Westfield Group will receive from its development, leasing and management fees. In gross terms, asset sales in the half raised about $4.8 billion. Today’s Westfield Group result for the June half showed earnings up 31% and a return on capital of 11.4%. As a consequence of the US deal and the start of a $2 billion buy-back (Westfield has spent about $440 million so far) that return on capital should continue to rise. The strategic plan, and Westfield’s willingness to continue to pursue it aggressively, has given it a lot of firepower. The joint chief executives, Peter and Steven Lowy, said today the group now had about $10 billion of capital it could redeploy into higher-returning opportunities. There are quite a few of them already underway or in the pipeline. At present Westfield has $1.5 billion of projects under construction (its share is $1.2 billion), it expects to start new projects costing between about $1.25 billion and $1.5 billion in each of the next two years and says the identified pipeline of future developments is about $11 billion. There is demonstrated potential to recycle some of the capital deployed into those projects, or tied up in existing property assets, by selling interests in them into the existing joint ventures or creating new ones. Westfield’s centres tend to be high-end and have proven themselves through the crisis to be quite resilient despite the continuing difficulties being experienced by retailers here and offshore. In Australia, for instance, Westfield was able to extract increases in its average specialty store rents of 3.2% in the half and had comparable net operating income growth of 3.3% even though overall retail sales rose a meagre 0.9% and specialty retailers experienced only a 0.8% increase. As noted previously, the divergence between the experience of the landlords and their tenants – rents continually rising at rates out of kilter with the tenants’ experience – raises a question mark over the sustainability of the traditional business model for property centre owners at a time when retail is experiencing structural as well as cyclical change. The Lowys, of course, by stripping capital out of the property assets by selling interests in them to third parties have materially reduced their exposure to the prospect that in the longer term that risk becomes a reality.
This article originally appeared on <a target="_blank" href="https://www.businessspectator.com.au/">Business Spectator.</a>
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Westfield's twin vehicle structure delivering benefits

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Commonwealth Bank may have posted a record profit for an Australian bank and cemented its position as industry leader but Ian Narev wasn’t brimming with enthusiasm for the performance. Comments like: "this is a predictable result" and "this is a good result given the uncertain environment" and "revenue growth was subdued" and "lower credit growth and greater pressure on market-sensitive businesses" and "we will retain conservative business settings" were reflective of the generally modest and cautious tone of CBA’s presentation. And with good reason. On a cash basis CBA lifted earnings a meagre 4% on total income which grew only 2% over the year to June. Its second half earnings were actually 1% lower than those generated in the first half. While its return on equity was 18.6%, which is likely to prove sector-leading again, CBA’s ROE has slipped from 19.5% last year and is now well down on the 21.7% level at which it peaked ahead of the global financial crisis. As NAB’s third-quarter update yesterday showed, it is difficult to grow income and earnings meaningfully in an environment where credit growth is running in the low single digits and about a third of the levels experienced pre-crisis. It doesn’t help that banks' markets-related businesses are under pressure from the difficult conditions. The strategy for the major banks has shifted very discernibly from top line and volume-driven growth to introspection and a focus on costs and credit quality. In CBA’s case, operating costs were up 3% but impairment charges down 15%. With funding pressures still acute and no obvious catalysts for a change to the risk-averse stances of consumers and businesses the outlook for the near term, at least, is for more of the same. Despite all the controversies around the major banks’ retention of some of the Reserve Bank’s reductions in official interest rates the funding squeeze on the banks is real, driven by increased wholesale funding costs and the competition for deposits. If the majors are profiteering from their oligopoly, as some politicians keep claiming, they aren’t very good at it. CBA’s net interest margin of 206 basis points in the second half was six basis points lower than in the December half and 11 basis points lower than the same half last year, despite the retentions and some re-pricing of its business lending. Year-on-year the reduction in net interest margin was a more modest three basis points, although the contraction in the Australian business was five basis points. Part of the explanation for the relatively stagnant performances of the majors is their defensiveness, which is understandable given the continuing fragility and risks within the global economy and financial system. It was a notable feature of the CBA result that there was only modest balance sheet growth (about 5%) and that in most of its key business lines it was content to simply hold share or even allow it to slip a little. Its focus continues to be on shoring up its balance sheet and its composition. It continues to shift the mix of funding away from wholesale to deposits – 62% of CBA’s funding is now provided by deposits – while also lengthening the maturities of the wholesale book. The average maturity of CBA’s new issuances in the year to June was 5.2 years compared to the overall average maturity of 3.7 years. It is also holding a lot of returns-sapping liquidity – $135 billion compared with $101 billion in June last year and $86 billion in 2010 – and has a conservative tier one capital ratio of 10%. As a sector, the Australian banks have positioned themselves as strongly as they can to respond to another outbreak of global crisis. The other feature of CBA’s result is that the group, which has a technology lead over its peers, is continuing to invest heavily – it spent almost $1.3 billion last financial year after investing $1.2 billion the previous year and $1 billion in 2010. The goal of the investment program isn’t just to drive productivity gains, which it is doing, or to enable the development and faster rollout of new products, which is occurring, but also to in effect "future proof" CBA from the rapid evolution of banking technologies and the threat that could be posed in the form of new and innovative entrants.
This article originally appeared on <a href="https://www.businessspectator.com.au/" target="_blank">Business Spectator.</a>
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CommBank's earnings were meagre, and its return on investment has slipped

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When he flagged his retirement last month, long-serving Stockland chief executive Matthew Quinn described the housing cycle as the worst he has seen during his long career in the property sector. The presentation for today’s Stockland result provides some context for that comment. 
With an overall result that was in line with the group’s downgraded guidance, the most notable feature of the 7% fall in group earnings was a 15% decline in the contribution of its residential communities division – despite record settlements and steady prices. 
There was a tone of slight bemusement to the presentation because in Stockland’s view the fundamentals for the residential property market are strong, with the market under-supplied, it believes, by between 130,000 to 240,000 homes. 
Until the financial crisis erupted, there had been a strong correlation between population growth and dwelling starts and, while they fluctuated, demand and supply were broadly balanced. 
The crisis, however, has produced a decisive break away from the longer term trends, with dwelling starts declining slightly even as population growth spiked, leading to the claimed shortfall in supply. Consumer anxiety and the continuing issue of affordability, however, has meant the shortfall hasn’t been reflected in pricing, which in Stockland’s case is flat-lining. 
That’s despite the Reserve Bank cutting official interest rates four times in the past nine months, by a total of 125 basis points. Traditionally rate cuts have flowed almost immediately through to housing market activity levels. 
Stockland said that before the financial crisis a 2% rate cut would result in a 10% increase in housing credit growth; post-GFC it has resulted in only 3% credit growth. In past cycles dwelling approvals picked up within three months of a rate cut; today approvals have declined. 
Stockland has started this financial year with only 1,561 deposits for its houses, 700 fewer than last year. It points the finger at Victoria, where it says 2011-12 activity was boosted by government stimulus. Victoria, of course, has been most adversely affected by the pressure on manufacturing industry generated by the strong dollar and the post-GFC defensiveness and deleveraging within business and households. 
In 2011-12 the margin within the residential communities division fell from 29% to 25%. Stockland obviously doesn’t expect any immediate improvement in the environment for new housing because it expects further margin compression this financial year, although it says there are signs that the market is near the bottom. 
Given the overall state of the residential property market, where prices have been sliding over the past year, there is no particular reason for buyers to rush into the market even in the lower rate environment. The shortfall in supply, however, does provide some underlying support for prices. 
There was a somewhat happier outcome within another segment of Stockland’s businesses that has also been under pressure. It has become increasingly evident since the financial crisis that there are both cyclical and structural changes occurring in retailing that have combined to exert acute pressure on the sector. 
As a major owner of retail property centres Stockland might be expected to have shared some of that pain. Its retail division, however, produced a respectable 8% improvement in earnings, with near 100% occupancy of its centres. The centres generated average turnover of $7526 per square metre compared to the industry average of $6,571. 
Quinn recognised quite early that the post-GFC downturn wasn’t just cyclical but was, with the boost from the Australian dollar, accelerating a structural shift in retailing as online sales started to grow from a modest base. 
While the rate of growth in online sales has slowed recently, they now account for more than 5% of total retail sales. That has obvious implications for traditional retailers and their landlords. 
Stockland’s response was to accept that the online channel would continue to grow and recognise that by far the largest segment of those online sales was fashion. 
It has re-weighted the tenancies in its centres away from fashion – only 25% of the capacity of its centres is devoted to fashion against an industry average of 33% – and towards food and services, while also shifting the emphasis within its clothing tenancies towards the value end of the market. About 56% of its specialty clothing retails are in that segment, against an industry average of only 5%. 
While the flagship retail centres, like Chadstone in Victoria or Westfield’s Bondi Junction have established themselves as destinations and are therefore less vulnerable to the combined effects of a retail recession and the gathering momentum of the invasion of the online retailers, lesser centres are going to have to emulate Stockland and shift the mix of their offering away from the more vulnerable categories or face a reversal of the historical trend of ever-increasing rental income streams and centre valuations. 
Quinn may have wished for a somewhat brighter note on which to end his 11-year tenure as Stockland’s chief executive but in both the retail and residential properties divisions he has positioned the group at the value end of the market, which is enabling it to work through some very difficult conditions and which will leave it well-positioned for any improvement in the environment.
This article originally appeared on <a href="https://www.businessspectator.com.au/" target="_blank">Business Spectator.</a>
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Why Stockland's departing CEO Matthew Quinn is leaving on a win despite fall in profits

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The Reserve Bank could easily have sat on its hands for a while longer and waited to see how the crisis within the eurozone and the slowing of China’s economy plays out before following up last month’s 50-basis-point cut to the cash rate. The fact that it didn’t signals its concern about the conditions both offshore and within the domestic economy.
The 25-basis-point cut announced today takes the cash rate back to where it was in November 2009, when the world was emerging from the nadir of the original financial crisis and within a single 25-basis-point move of the low point of that cycle in official rates. That provides a useful barometer of the current economic and financial climate.
There were a number of reasons why the RBA shouldn’t have cut today.
The new Greek elections on June 17 are likely to be another flashpoint in the eurozone crisis. European leaders are trying desperately to put together a new (some cynics might say ‘first’) ‘’masterplan’’ to escape a eurozone implosion. China is trying to rekindle growth.
Within the Australian economy we’ve yet to see the full impact of last month’s 50-basis-point reduction in official rates (less what the banks retained), or the impact of the Gillard government’s latest $2.5 billion cash splash or the recent significant decline in the value of the Australian dollar.
There was also, <a target="_blank" href="/news">as discussed previously</a>, the issue of preserving as much of the RBA’s diminished capacity to stimulate as it could in case the eurozone does blow up.
There were, therefore, reasons why deferring a move until both the global and local circumstances became a bit clearer might have been a rational decision.
Yet the RBA decided to move, albeit by a modest 25 basis points, which will probably end up being slightly less than that after the banks have trimmed it to offset their increased funding costs. By itself, 25 basis points, or whatever ultimately flows through to households, isn’t going to turnaround the increasingly defensive sentiment of consumers.
That says that the RBA is concerned. It is worried about Europe. It is worried about China. It is worried about the domestic economy. As it should be.
Europe is a basket case and has, as the RBA noted, the potential to generate shocks that would be transmitted through the global financial system and economy. Issues of fiscal sustainability (the eurozone’s fiscal settings can’t be sustained) and its under-capitalised banking system represents a severe threat to global economic and financial stability.
The US is experiencing anaemic growth and faces a shock of its own next January, when the withdrawal of the Bush administration’s tax cuts and mandatory cuts to government spending will yank about $US7 trillion out of its economy, probably forcing it back into recession.
China’s attempt to stamp out a property-centric bubble has been successful, perhaps too successful and it is now, in a year when its leadership will change, trying to rekindle its growth rate.
Its slowdown, and the reality that Europe and the US – approaching half the world’s GDP and China’s two biggest markets – are under continuing pressure has impacted commodity prices, and the Australian dollar and placed a question mark over the uncommitted slabs of what had been a $500 million-plus pipeline of resource project investments in this economy. It hasn’t helped, of course, that the costs of developing those mining projects have been blowing out at a greater rate than almost anywhere else in the world.
The RBA noted significant variations between sectors of the Australian economy, while saying there had been modest growth in the first part of 2012. It also referred to ‘’job shedding’’ in some industries (which appears to be accelerating in the non-resource segments of the economy) and the ‘’precautionary’’ behaviour of households and businesses. (The imminent carbon tax got only a passing reference in relation to its technical impact on inflation rather than its psychological, and real, impact on households and businesses).
After last month’s rate cuts the actual lending rates for borrowers were slightly below their long-term averages but demand for credit remains low as households and businesses continue to deleverage. Despite the cut, house prices – which had been stabilising – have resumed their decline.
The litany of woe and worry and the likelihood that the banks will hang onto at least a sliver of the 25 basis points was, if anything, an argument for a 50-basis-point cut.
The 25 basis points could suggest a bet each way – preserving firepower, keeping the stimulatory impact (once the banks have taken their share of the reduction) modest, seeing whether the weakening of the dollar alleviates some of the pressures on the industrial economy and awaiting anxiously the denouement of the eurozone crisis that the Greek election and Spanish banking crisis might provide.
This article originally appeared on<a target="_blank" href="https://www.businessspectator.com.au/"> Business Spectator.</a>
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The RBA could have kept rates on hold

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The backdrop of a tumbling stock market, surging job losses and sliding dollar will reinforce the market’s conviction that the Reserve Bank will again cut the cash rate at its meeting today. For the RBA board members however, it’s not going to be an easy decision. The market has been pricing in the 100% probability of a 25-basis-point cut to the cash rate tomorrow and something approaching an 80% probability of a 50-basis-point reduction. The turmoil in markets sparked by poor US economic statistics on Friday can only have strengthened the belief that the RBA will act. In fact the market has priced in a whole series of rate cuts, expecting the cash rate to tumble from 3.75% today to 2.25% by December. That may well eventuate, although it would be a signal of real distress within the global and domestic economy if it did. There are a range of factors that will give the RBA board pause for serious thought about whether or not to follow May’s 50-basis-point rate reduction with a further reduction. One of the more obvious is that it knows from the May experience, when the banks declined to pass through the full 50 basis points (which the RBA anticipated and built into the decision to cut by 50 basis points rather than its conventional 25 basis points) and from its continuing engagement with the major banks that they would almost certainly again retain a proportion of any official rate cut. The impact of a 25-basis-point reduction in the cash rate would be muted if the banks, still experiencing pressure on their net interest margins from the competition for deposits, hung onto five or 10 basis points. That means the RBA, if it wants to generate some meaningful stimulus, would need to seriously contemplate another 50-basis-point cut. With the cash rate at 3.75%, reducing rates by half a percentage point at a time erodes the potential for the RBA to take really decisive action if the situation demands it, as it may well do.  Europe is on the verge of imploding, with the new election in Greece still two weeks away, the US has slowed again and even China is starting to feel the effects of the recessed global conditions and its own attempt to rein in inflation last year. If the Europeans can’t devise some mechanism for stabilising their dangerously unstable fiscal positions and recapitalise their dangerously under-capitalised banks then the RBA, and the Gillard government, are going to need all the monetary and fiscal firepower available to them.  During the worst of the first phase of the global financial crisis the RBA cut rates six times, by a total of 300 basis points, between September 2008 and April 2009. The Rudd government also doused the economy with cash. If Europe implodes then the stretched state of government finances in Europe and the US, and the somewhat more limited ability of China to repeat its massive stimulus strategy, may dictate an even stronger stimulatory response here. The RBA may want to preserve its firepower for when it is really needed. The board would also, no doubt, consider whether there has been sufficient time to determine whether last month’s rate cut has had any positive impact – monetary policy usually takes some time to have an effect – and would be conscious that while the most recent federal government cash handouts are flowing to households, the full impact of the $2.5 billion in school kinds bonuses and the pre-emptive compensation for the carbon tax has yet to be felt. (Has there ever been worse timing for the introduction of a great big new tax?) It would also be mindful that the settings for a key influence over the recessed conditions in the non-resource states are changing. When the Reserve Bank met last month the Australian dollar, while trading a long way short of the high of $US1.10 it reached in the middle of last year, was still comfortably above parity at $US1.02. Today it slipped below 97 US cents. That will relieve some of the pressures on local companies and be mildly stimulatory, although the currency is still trading way above historical levels. There is no doubt that the non-resource sectors of the economy are struggling. The retail and manufacturing sectors are being ground down by the erosion of consumer confidence and the significant household deleveraging that is occurring. The job losses and corporate failures are mounting and house prices continue to slide. The investment boom in the resources sector continues – but the pipeline of projects yet to get underway is shrinking rapidly. There has been a massive loss of confidence that will be further impacted by the fall in the Australian share market below 4000 points today and which one suspects won’t be turned around, whatever the RBA might do, unless and until federal parliament is functioning more conventionally and Europe has been stabilised. The RBA board will have to weigh up complex competing arguments as to whether or not to cut rates again and, if so, by how much. It will have to think its way through likely developments, and their likely timing, in Europe and the US and how it might be forced to respond. Despite the market’s certainty, it is most unlikely to be a straightforward decision.
This article originally appeared on <a href="https://www.businessspectator.com.au/" target="_blank">Business Spectator.</a>
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Today’s RBA decision is not going to be easy: Bartholomeusz

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The fallout from the collapse of Hastie Group is already ugly, with thousands of jobs in jeopardy and hundreds of millions of dollars of losses for the banks in prospect. It could, however, get even uglier. Hastie’s directors, its auditors, its senior management and former senior managers will be feeling very uneasy in the knowledge that not only will the Australian Securities and Investment Commission delve deeply into the circumstances that led to the group’s collapse but that there is also a group of very wealthy and very angry investors which will be looking for retribution, and compensation for their losses. In the words of Hastie’s administrator, PBB Advisory’s Ian Carson, the $23 million or so of accounting ‘’irregularities’’ found very late in the attempt to keep the group afloat were the ‘’straw that broke the camel’s back,’’ rather than the key reason for the collapse. That those irregularities appear to date back as far as 2008-09, and may be part of a wider series of financial misrepresentations, however, could be a very real issue for those with an exposure to the company’s implosion. It is known that Hastie’s relatively new chief executive, Bill Wild, wasn’t happy with the group’s numbers even before the latest batch of irregularities emerged. Those irregularities, which Wild has said were part of a culture of covering up bad news rather than motivated for personal gain, did sink the last-ditch attempts to convince competing private equity firms to recapitalise the group in recent weeks. Those attempts weren’t helped by deep divisions within Hastie’s banking syndicate, which has an exposure to Hastie’s debts and performance guarantees of around $500 million. For the four of the seven banks that supported a recap, the accounting irregularities proved to be that final straw. With Hastie saying that some current and former senior managers may have participated in the accounting irregularities and failed to apply the appropriate standards of financial supervision and review, the class action law firms and financiers will be scrambling onto a war footing. The real danger for those who were in control of the group’s affairs around this time last year lies within Hastie’s last recapitalisation. Last year, as a result of difficult trading conditions and the group’s poor operating and financial performance, Hastie said it was at risk of breaching its banking covenants. To head off that risk, Hastie raised $160 million of new equity through a prospectus offering, which included directors’ forecasts, underwritten by UBS and Macquarie. The investigating accountant for that offer was Hastie’s long time auditor, Deloitte. The prospectus was obviously convincing enough to attract some heavyweight investors. Lazard Private Equity*, Schroders, Perennial and the Pratt family’s Thorney Investments came onto the Hastie register, with Lazard, described as the ‘’cornerstone’’ investor, stumping up about $50 million for a 25 per cent stake in the group. Less than 12 months later – the recapitalisation and a restructuring of the banks’ funding were completed in July last year – Hastie has collapsed. Little wonder those who invested on the strength of the prospectus and the representations made by the board and its senior managers, are seething. One of those managers – former CEO David Harris, who presided over a massive acquisition-driven expansion spree – departed the group last November. Within a month of joining the group Bill Wild and his new chief financial officer Mark Wratten had started a strategic review of Hastie’s Middle East and international operations and were beginning to understand how poorly the group had been structured and managed. It was losses in the Middle East, and the disputed calling of performance bonds in relation to a project in the Middle East, that plunged Hastie back into crisis and ultimately led to its demise but it is the relative proximity of that prospectus last year to the collapse that is going to cause quite a few people associated with the company and the raising some extremely anxious moments. *John Wylie, managing director of Lazard Australia, is an investor in Australian Independent Business Media, publisher of Business Spectator.
This article originally appeared on <a href="https://www.businessspectator.com.au/" target="_blank">Business Spectator.</a>
 
 
 
 
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Hastie Group collapse could get even uglier: Bartholomeusz

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Conventionally a 50-basis point cut in official interest rates ought to trigger alarm bells. But now it could just be evidence of the Reserve Bank’s relatively new-found pragmatism. Moving the cash rate by something more than the usual 25 basis point increments is unusual. The last move of more than 25 basis points – and there were four successive moves of more than 25 basis points, three of them by full percentage points – was in the midst of the worst of the global financial crisis in late 2008 and early 2009. In other words, in the past, anything more than 25 basis points was a signal that the RBA was truly concerned about the state of the economy. It might well be today, even though domestic demand has been running at its fastest level for four years. Every day brings fresh news of company failures and job losses in the non-resource side of the economy. In the RBA’s own words, ‘’considerable structural change’’ is occurring within the economy. The continuing strength of the Australian dollar is exerting enormous pressure. The RBA, however, has also been at pains over the past 12 months to make it clear that it uses the cash rate to target the actual rates borrowers will pay for their funds within a different environment to that which prevailed pre-crisis. Then the banks generally simply passed on the RBA’s decisions. Today they don’t. Whenever a senior RBA official speaks publicly about monetary policy these days they make the point that, while they can influence the absolute level of interest rates within the economy, they can’t dictate the margin over the cash rate actually paid by the banks for their own funding. As the RBA said today, while wholesale funding costs for the banks have been declining, they remain higher, relative to benchmark rates, than they were in the middle of last year. There has also been a fierce battle between the banks for domestic deposits as they try to reduce their reliance on offshore wholesale funding. Going into today’s board meeting the RBA, whose staff maintains a continuous dialogue with the major banks, would have known that if it cut by 25 basis points the major banks would, in this new environment where the relationships between their funding costs and the cash rate has been de-linked, have retained 10 to 15 basis points of the reduction in the cash rate. A 25 basis point cut would end up as a 10 to 15 basis point reduction in lending rates and therefore be largely immaterial in terms of its impact on the real economy. By opting for a 50 basis point cut the RBA has effectively ensured that it will probably get 35 basis points to flow through to borrowers, which would have a much more significant impact on the psychology of borrowers and their real interest costs. In the process it has practically invited the banks to hang onto some of the reduction. One way to interpret the move would be to say that it indicates some concern by the RBA about the state of the economy but not the kind of fear that drove those percentage point reductions during the worst of the financial crisis. That might change if Wayne Swan actually delivers the $40 billion-plus contraction in the economy implied in his promise to bring the budget back into surplus. The state of the world that informed the RBA’s decision is as it has been for some time. Global growth is weak, with the US producing anaemic growth off a very low base, Europe still on a knife edge and China in a controlled slowdown. Our terms of trade, while still high, are well off their peak but the Australian dollar remains at historically high levels. Inflation is a non-issue – the March quarter numbers that cleared the way for today’s rate cut were weaker than anticipated and are running at the bottom of the RBA’s targeted range – and employment is softening.  House prices are still sliding and consumers and businesses are in defensive modes. The RBA would also be well aware that the banks are unlikely to use the rate reduction to go on an orgy of lending – they are more interested in shoring up the funding side of their balance sheets than expanding their asset bases. That’s another reason why they won’t pass on the entire reduction – they have been very successful in attracting term deposits, whose cost they can’t change quickly. With the cash rate now at 3.75 per cent the RBA has less room to manoeuvre if Swan does deliver his horror budget and it is greeted with horror by consumers and business, but it still has more scope to cut rates than almost any of the developed world’s central banks. During the original crisis, in April 2009, the cash rate got down to three per cent. While politicians and borrowers love rate cuts, let’s hope we don’t see the cash rate at that level again because the bells would then be tolling very loudly.
This article originally appeared on <a href="https://www.businessspectator.com.au/" target="_blank">Business Spectator</a>.
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When an interest rate cut of 50 basis points doesn't equal panic: Stephen Bartholomeusz

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After last month’s Reserve Bank board meeting governor Glenn Stevens made it fairly clear that if the March quarter inflation numbers were benign the bank would be inclined to cut official interest rates. Well, the numbers are in, inflation is even weaker than was anticipated and the debate has shifted from whether the RBA will cut to how much it will cut. 
With headline inflation of 1.6% and underlying inflation of 2.2% there was nothing in today’s numbers to suggest anything other than that the economy is continuing to weaken. 
Consumer spending is at recessionary levels, the housing market is in a similar state, job losses in the manufacturing sector are mounting, the impact of the continuing (albeit tapering) boom in the resources sector isn’t flowing through to the rest of the economy and Wayne Swan is about to attempt to pull about $40 billion out of the economy, or 2.5% of GDP, if not more. Some of that may be done with "smoke and mirrors" but it isn’t going to be possible to achieve those sorts of numbers without real and very substantial cuts in expenditures and increases in government revenues. In the circumstances, the horror budget that is looming can’t be considered as anything other than a major depressant on an already weakening economy. In that context, a reduction in official interest rates next Tuesday appears inevitable. The larger question, however, is whether that would be sufficient to blunt the negative influences now pervading the economy. It is a question complicated by the RBA’s need to second-guess the responses of the major banks to a rate cut, given that there is a probability that they will retain at least some proportion – perhaps 10 to 15 basis points – of any reduction.  Led by ANZ, the banks have to a degree de-linked their mortgage and deposit rate movements from the RBA’s decisions and they have been making it plain that they are continuing to experience the funding pressures that have caused them to pass through rate cuts lower than the movements in official rates since the onset of the financial crisis. If the RBA cuts the cash rate by 25 basis points next week and the banks pass on only 10 to 15 basis points of it, would the decision have any meaningful impact on the economy and the psychology of consumers and businesses? One doubts it. That’s why there are plenty of people now focusing on the prospect of a 50 basis point reduction in the cash rate, which would allow the banks to retain their 10 or 15 basis points while still enabling a meaningful reduction to flow through to borrowers. No doubt the RBA staff has been in close contact with the major banks to make sure they understand their likely responses to a cut. The RBA has made it clear that it does take the anticipated reaction of the major banks to rate movements into account when deciding whether to move the cash rate and the size of the movements. It is concerned not about the level of the cash rate per se, but the influence it has on the actual rates being charged borrowers. The one issue that might make the RBA cautious about the size of any reduction would be the looming federal budget. It might want to see the nature and quality of Swan’s budget measures – how "real" they are – before moving more than the usual 25 basis points. However, with commodity prices and the terms of trade now off their peak, China slowing, Europe still wobbling, swelling question marks over some of the biggest of the new resource projects in the pipeline, the non-resource economy slowing discernibly from already weak levels, households confronted with rising utility costs and the carbon tax imminent, if the RBA doesn’t lop 50 basis points off the cash rate next week the probability is that there will be a succession of rate cuts between now and the end of the year.
This article originally appeared on <a href="https://www.businessspectator.com.au/" target="_blank">Business Spectator</a>.
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Size all that matters now for RBA interest rate cut: Stephen Bartholomeusz

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Friday’s minor rate movement by ANZ was the rate increase, for both fundamental and tactical reasons, the bank had to make.
In the scheme of things six basis points is neither here nor there, and certainly not something that deserved Wayne Swan’s mock outrage. Swan seems to have forgotten that the last time ANZ lifted it home loan rate, in February, it did so by the same six basis points – and the other major banks (and some not-so-major banks) responded with increase of between nine and 15 basis points.
So, to a degree, ANZ was only playing catch-up on Friday.
There is a fundamental justification for the banks increasing their rates slightly. They do have longer term pre-crisis borrowings continually maturing that have to be re-financed in the current market.
While wholesale borrowing costs are lower than they were at the height of the global financial crisis and have been broadly trending down (apart from a spike in recent weeks as fears about the stability of the eurozone flared again), they are still elevated, which means the banks’ average borrowing costs are still edging up as the longer-term borrowings are re-financed.
The other fundamental reason for raising the cost of lending is that banking is essentially two-dimensional – there is both an asset and liability side to banks.
On the asset side, demand for credit is extremely weak. There is no volume growth in the system to offset the pressure on margins from higher funding costs. On the liability side there is fierce competition for deposits as the banks try to reduce their exposure to the volatile and unreliable wholesale funding markets.
That competition is continuous, given that term deposits have relatively short maturities, and is likely to be a long-term feature of the system because all the banks are targeting even higher proportions of deposit funding over time.
That means there will be continuing upwards pressure on the relative cost of those deposits – the interest rates the banks have to offer to attract and retain them – and therefore pressure to re-balance the pricing of the relationship between borrowers from the banks and lenders to them.
From the perspective of the whole system, adding a marginal disincentive to borrowings and a marginal incentive for savings – slightly re-balancing the relationship between savings and borrowings in favour of savings – is not such a bad thing.
Tactically, the ANZ needed to restore its capacity to compete for deposits without sacrificing margin relative to its peers. It also needs to get its customer base used to frequent small movements in its rate – in both directions – if its bold new rate-setting policy is to be effective.
In December, ANZ announced it would in future set its rates independently of the Reserve Bank’s first-Tuesday-of-the-month board meetings, reviewing them every second Friday of the month. The strategy was to de-link ANZ’s rate movements from the RBA’s to emphasise that bank funding costs aren’t set by the RBA decisions.
The RBA can strongly influence the absolute level of rates in the market, but not the price investors demand from borrowers relative to its cash rate, and the key issue for the banks is not the absolute cost of funds but the spreads they experience over the cash rate relative to those they charge borrowers.
For ANZ’s new approach to rate-setting to work, it really needs to move its borrowing rates regularly, ideally in both directions and by modest amounts, to get its customers used to the notion that funding costs are moving continuously without getting too far out of kilter with its competitors and therefore creating a competitive vulnerability.
Friday provided a major opportunity. Not only was ANZ largely playing catch-up with its peers, which makes it harder to argue it was somehow profiteering at the expense of its customers and therefore has made it a smaller target for the bank-bashing brigade, but the RBA made it clear after holding official rates unchanged earlier this month that if the March quarter inflation numbers don’t contain any nasty surprises when they are disclosed on April 24 it is likely to cut the cash rate.
If that were to happen, and it is probable albeit not certain, a 25-basis-point reduction in the cash rate would more than compensate borrowers for ANZ’s six basis point increase – and also provide another opportunity for all the banks to hang onto some of the reduction. ANZ’s move increases the probability that the RBA will cut official rates.
The RBA has been saying consistently in recent times that the banks have a case when they argue their margins have been eroded by rising funding costs and that it takes that into account in its own rate deliberations. In fact, it has said that official rate would be a full percentage point higher if the banks had simply been passing on official rate movements.
It uses the cash rate to target the actual lending rates within the economy that it believes are appropriate for the state of the economy.
In that sense, in terms of the rates borrowers actually pay, what ANZ or the other big banks do is largely irrelevant – if the RBA thought the banks would retain all of a 25 basis point rate reduction, but wanted the entire reduction to flow through to the economy, it would simply cut official rates by 50 basis points. It makes monetary policy slightly more complicated but not necessarily less effective.
ANZ’s rate-setting policy, while it adds noise to the process – and hopefully a better understanding among borrowers, depositors and politicians about the relationships between official rates and the rates bank customers pay and receive – doesn’t change it because the RBA knows the bank can’t move significantly away from its competitors.
This article originally appeared on<a target="_blank" href="https://www.businessspectator.com.au/"> Business Spectator</a>.
 
 
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Stephen Bartholomeusz

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