Room for a greater rate cut?

Given yesterday's CPI print the Reserve Bank will be comfortable cutting the cash rate in May, and speculation will mount that it could do so by 50 basis points.

Property Observer

For months the Reserve Bank of Australia has said it would patiently wait for the consumer price data to confirm that the door was open to rate cuts. It got unambiguous affirmation of that reality from the ABS at 11.30am on Tuesday.

In the best possible news for Australia’s economy, core inflation printed at just 0.35 per cent in the March quarter. Despite some small upward revisions to last year’s fourth-quarter data, core inflation in Australia is sitting near the bottom of the RBA’s target 2 per cent to 3 per cent per annum band at around 2.2 per cent.

But there is possibly more good news to come. Next quarter the annual inflation numbers will lose the very high underlying inflation print from way back in June 2011. This implies that the annual inflation figures could slide further in the second quarter of 2012.

What does this mean for interest rates? In my last column I provided a 'cheat sheet' based on a range of different outcomes today, which I have enclosed below. We ended up getting a result that arrived somewhere between the top two rows of my table. As you can see from the right-hand-side column, this connotes a minimum 25-basis-point cut in the RBA’s official target cash rate come May.

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Speculation will mount that the RBA could go even further with a 50-basis-point cut. One of the most persuasive arguments for this action is additional margin expansion by the banking community.

Assuming the RBA cuts by 25 basis points in May, we will have had a total of three cuts, or 75 basis points worth, since November. If the other banks follow ANZ’s six-basis-point hike by a similar margin, the net benefit to Aussie borrowers would have been 55 basis points, or two rate reductions (taking May as given).

Yet the RBA will probably choose to wait until it has the benefit of seeing the Gillard government’s budget after its May meeting. If it does so, its view of the world remains unchanged, and, finally, the banks do not pass on the May cut in its entirety, then the probability of follow-up relief in June would rise materially.

The low inflation numbers deliver the best of all possible worlds for Australia’s torpid housing market. Mortgage rates are currently around their average levels. However, long-term interest rates, as measured by 10 year government bond yields, are at all-time lows. This should allow banks to further cut the cost of fixed-rate home loans, all things being equal.

In addition to lower fixed-rate loans, the 4 million-plus Australian borrowers on variable-rate loans will get a third rate reduction in May with the prospect of a fourth bout of accommodation in June. Given the news on prices today, the RBA will be comfortable pushing lending rates into 'stimulatory' territory – that is, levels that are lower than their long-term averages.

The latest auction clearance rate data in the two biggest auction markets, Sydney and Melbourne, suggest that the overall market is travelling okay. Last weekend auction clearance rates in both cities hit circa 60 per cent, according to RP Data. This followed a noticeable slump in clearance rates, and housing conditions more generally, during the traditionally weak Easter period (see chart below).

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In 2012, the Aussie housing market has displayed some signs of stability after the consistent declines experienced during 2011. We forecast this result on the basis of the RBA’s two rate cuts in 2011, although the banks have chiselled away at this relief. The market’s 2012 base is evident in the chart below, which illustrates the 30-day moving average attributable to RP Data-Rismark Eight Capital City Dwellings Index.

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Finally, there are tentative signs of life in the zombie-like, ultra-premium part of the market. It was reported today that a holiday home in Palm Beach sold for a record price will in excess of $20 million which, if correct, smashes the previous Palm Beach record of around $14 million. This home had only been listed for seven months before it was snapped up. (Disclosure: a related party was involved in the transaction.)

Christopher Joye is a leading financial economist and a director of Yellow Brick Road Funds Management and Rismark. The above article is not investment advice.

This article first appeared on Property Observer on April 24. Republished with permission.

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