Bad Time For a Rate Rise?

Is now really a good time to raise interest rates? Sure there's a lot of optimism about, but that's not going to pay the mortgage. The latest retail sales should serve as a warning that the economy's not as healthy as we're being led to believe.

Australia's retail sales in February dropped 12 percent. Having given our credit cards a good workout in the January sales we expect a drop at this time of year, but at $17.5 billion monthly retail turnover is lower than expected. So if you were the Reserve Bank of Australia (RBA) wouldn't you want to wait a month or two to check that sales bounced back before you made your next move?

So what's the rush? Is it a fear of runaway house prices, which are now out of control in parts of the country? Whatever the problem, the medicine could prolong the Global Financial Crisis (GFC) if it's dished out too early. Here are five reasons for concern:

1. Retail sales look like they still need a stimulus Most people agree the stimulus package was a good thing. Economist Nicholas Gruen says it's the "best bit of policy we've pulled off in many a long time". Yet even with the stimulus we were more careful than usual with our spending. Department store sales for the year to February were just 3 percent higher than the year before, hardly solid growth, and the Commonwealth Bank's inaugural Viewpoint analysis showed a fall in the average credit card transaction, likely resulting in a squeeze on retail margins. The retail sector still has a battle to get back on track.
2. The RBA has introduced an un-stimulus package. We've gone from the government giving people money, to the RBA taking it away, all in the space of a few months, an approach unique in the world. This week saw the fifth increase in rates since Glenn Stevens decided the worst of the GFC was over. He believes unemployment has peaked and terms of trade are increasing investment and creating jobs. How can there be such a massive turnaround and why the haste if it's not really all about house prices?
3. NSW may be a warning Interest rates impact retail spending, that goes without saying. The hope is that the economy grows fast enough to create new wealth to compensate, but that's not happening yet. The larger-than-expected fall in February is testament to that. Retail sales fell sharpest in NSW, where mortgage debt is highest --- a 13.3 percent drop against a national fall of 11.9 percent. In 2008 the average spend per person was about $10,000 in NSW, compared to $11,100 in Queensland and $11,800 in WA. Put simply, you can spend more on retail therapy if you don't have a large mortgage noose hanging over your neck.
   
4. NSW bounced back when rates were low When the RBA dropped interest rates last year, retail sales in NSW jumped 7 percent against 5 percent in all other states. The year before, when interest rates were peaking, NSW retail spending grew by just 2 percent, compared to 6 percent in other states. Now the rates are back again we've seen this 13 percent drop in NSW. Try telling me that's nothing to do with mortgage rates.
5. Business optimism can be misleading Most surveys of business confidence are bullish about jobs and sales, but the Commonwealth Bank ACCU Business Expectations Survey notes that in recent quarters expectations have not been met by reality. Talk can only get you so far.

So the RBA is walking a tightrope. It's clearly got rising house prices in its sights, but the downside could be a bigger-than-expected hit in retail sales, affecting jobs and delaying a recovery. You've got to hope it knows what it's doing, but if you've bought a house in Sydney lately (and Melbourne is going the same way) you've got to wonder.

View the full February retail statistics here.