Low rates are no longer having the powerful effect they once did, and this has implications for the whole economy, writes Clancy Yeates.
The last time mortgage interest rates were this low, in late 2009, many Australians responded by piling on cheap debt.
Within a year of rates being slashed during the global financial crisis, the average loan for someone entering the market had jumped $15,000 to near $285,000.
Helped by government incentives, first home buyers' share of new loans surged as high as 30 per cent, with up to new 18,000 issued per month. Today, however, their response to cheap credit could hardly be more different.
There were just 7300 loans issued to first home buyers in June, less than half the number seen in the previous period of low rates. Their average loan amount has barely budged in almost four years. Meanwhile, many people who already have mortgages are using rate cuts to pay off their debts more quickly.
"What we are seeing in the main is mortgage holders electing to retain their current repayment amounts as interest rates fall in order to accelerate the repayment of their home loan," Mortgage Choice chief executive Michael Russell says.
This is a distinct change from the previous wave of rate cuts, which enticed people with mortgages to use the windfall to fund increased spending, or borrow more.
"Dropping rates, you were able to bank on an increase in demand for retail spending and increased demand for property," Russell says. "What's happened in the last few years is that linkage has been severed."
There are various reasons for this trend, but one fact is clear: rate cuts are not having the powerful effect on people's behaviour that they once did. And this is not just a concern for those with a vested interest in the housing market. It has implications for the whole economy.
When someone buys their first property, for instance, they are more likely than investors to buy a newly built home, providing jobs for construction workers. They are also more likely to go to Bunnings or Harvey Norman to buy furniture or appliances, stimulating retail.
The reaction from businesses to low rates has also been soft: latest figures show firms are sitting on $400 billion in cash or bank deposits rather than choosing to invest.
The Australian Chamber of Commerce and Industry's chief economist, Greg Evans, sees little chance of this improving soon.
"Business owners are wary of debt and weak demand conditions provide uncertainty about the capacity to service and repay new facilities," he says.
"We expect it may take some time for this conservative but reasonable assessment to unwind."
All of which raises some critical questions for the health of the economy. Why are we so hesitant to respond to the prodding from the Reserve Bank?
If there has been such a sharp change in our attitude towards debt, how much can we rely on low rates to get things moving again?
And by making debt so cheap, what are the risks of inflating a dangerous asset bubble?
The cash rate may be at its lowest level since the 1950s after this week's cut, but the rates households actually pay are not quite at rock bottom.
Average advertised mortgage rates are now slightly above those of late 2009, at the tail end of the financial crisis. But unlike four years ago, the response from consumers has been tame. Annual growth in housing credit is only just above a record low, at an annual pace of 4.6 per cent, less than half the growth rate before the financial crisis.
Merrill Lynch economist Saul Eslake describes the reaction from households so far as "much more muted than history might have led you to expect".
A good way to illustrate this is through the property market - home to some $1.2 trillion in debt and perhaps the most interest-rate sensitive part of the economy. Among the 37 per cent of people with mortgages, there is a trend towards keeping monthly repayments steady, rather than spending the extra cash made available by a rate cut.
Prospective first home buyers, meanwhile, are struggling to get in the market because they are competing with investors. And the investors who are snapping up property are more likely to buy existing homes rather than new builds, resulting in weaker flow-on effects for construction.
"That has undoubtedly blunted the impact of monetary policy on households. That may mean that the RBA has to work harder to achieve the same result," Eslake says.
Renters and people who own their own home outright, meanwhile, are getting a lower return on their bank deposits. In short, very cheap debt is having a more limited impact on key groups in the market, because Australians appear much more financially conservative.
This marks a sharp change from previous experience, which had led the Reserve Bank to expect a surge in home building to pick up some of the slack created by declining mining investment.
So far, however, most of the action has been confined to sales of homes, rather then building new ones.
Auction clearance rates have been flirting with post-financial crisis highs, especially in Sydney, and the Australian Bureau of Statistics capital city house price index rose 5.1 per cent in the year to June.
But HSBC chief economist Paul Bloxham says the recovery in construction has been "tepid".
ABS numbers show private sector homes were rising for five months in a row until the latest one-month fall, but are still about 20 per cent below pre-financial crisis levels.
"Low interest rates are getting some traction in the housing market. What we have not seen is low interest rates get much traction elsewhere," Bloxham says.
"We expect that rising house prices will to start to provide more momentum for a further upswing in the coming quarters."
There is little evidence to suggest rate cuts are encouraging more spending by businesses, either.
RBA data show business credit is expanding at a yearly pace of just 0.9 per cent, much slower than 4.4 per cent a year earlier.
Eslake points out that businesses are sitting on $400 billion in cash, suggesting the cost of credit is probably not what is holding back investment decisions. "I don't think that the price of availability of credit is a reason for the weakness of non-mining business investment," he says.
A recent Deloitte survey of chief financial officers - the beancounters who have a critical say in approving investment - also showed confidence sunk to its lowest level since 2009 in the latest quarter.
What then, is the problem?
Many blame low confidence. ACCI's Evans says the cost of credit is indeed low, but we are grappling with the limits of cutting rates to revive growth because the economy is suffering from low confidence.
"The growth in business credit is still lacklustre and there is only very limited evidence at this stage that lower rates have encouraged a greater willingness to borrow," he says.
Bemoaning low confidence is a common complaint in the business community. But is it realistic?
It's true that measures of consumer and household are lower than normal, but they are far from recession levels.
Reserve Bank governor Glenn Stevens last week gave a longer-term explanation for the economy's softness, and stressed there was only so much he can do to change this.
"It would be good if there was a bit more confidence in the business community about the future. Unfortunately, it is not a straightforward thing to turn sentiment around. There's no such thing as the 'confidence policy lever'," he said.
While some are hoping the election will give the economy a much-needed kick-start, Stevens laid out some deeper reasons for the economic malaise.
Unlike previous rate-cutting cycles, the economy is now grappling with the end of two boom periods. The first of these is well known, a mining investment boom that probably peaked earlier this year.
The second, however, is a long-term build-up in household debt levels over the 1990s and early 2000s facilitated by a one-off shift towards lower interest rates.
It is this second boom - often overlooked - that resulted in the ratio of household debt to disposable income ballooning from 50 per cent in the early 1990s to 150 per cent in 2010.
Now, economists suspect the end of this second boom is also preventing many people from responding to interest rate cuts as they have in the past.
"This boom did not end in Australia as painfully as it did in some other places, but end it did," Stevens said.
When this deep-seated change is taken into account, the weak response to interest rates from households makes more sense.
Even so, slashing the cost of credit inevitably raises questions about the risk of creating bubbles in the future.
In April UBS analyst Jonathan Mott wrote that the ingredients were in place for "sustained house price inflation in Australia", especially in Sydney, citing cheap credit and an influx of investors. Since then official rates have fallen by another 0.5 percentage points, suggesting these risks have increased. Those on the other side of the age-old debate on Australian property, however, point out that what makes bubbles dangerous is rapid increase in debt. And all the statistics show this has not yet occurred.
Mortgage Choice's Russell says whether we are in a bubble is indeed a key question, but he has not detected any "warning signs" yet.
"Unlike previous housing market cycles, this recovery is definitely more subdued," Russell says. Indeed, with house prices forecast to rise after falling until mid last year, he argues it is "hardly surprising" investors are rushing back into property.
Bloxham says that some price inflation is needed to convince developers they will not lose money on investments and encourage the rebalancing away from mining.
"It's a necessary evil because you need prices to be rising in order to encourage a pick-up in construction. It's possible to have too much of a good thing but I don't think we're there yet."
Stevens, for his part, last year said he did not agree with claims that Australia had a property bubble, but said we would be "be flirting with danger were we to see a very big run-up" in house prices.
This week's statement from Stevens suggests he remains relatively unconcerned about these risks. It predicted growth in "interest-sensitive spending and asset values", but clearly this prospect was not enough to prevent him from cutting the cash rate to its lowest level in more than half a century.