Westpac’s decision to unilaterally lift home loan interest rates by 0.2% – and the likelihood that the other majors will now follow – has raised the chances that the Reserve Bank of Australia will counter the move by lowering official interest rates.
After all, the last thing the RBA want’s right now is a further downside risk to already fragile consumer confidence – not to mention a sudden “buyer’s strike” in the property market. Even before Westpac’s move there have been signs of a cooling in the Sydney property market, with auction clearance rates down and reports of sellers having to accept lower prices.
A cooling in the overheated Sydney market was inevitable – but we’ve been hoping that other areas of the economy (such as non-mining investment) would be taking up the slack when this happened. As it stands, the rest of the economy is still sluggish, and a souring in Sydney property prices now risks undermining one of the few bright spots for the economy, namely NSW consumer spending and employment.
The other risk relates to home building. Nationwide home building approvals are already near record highs and sign of cooling in home prices – along with the tightening in credit conditions faced by investors – could see approvals start to fall in the months ahead. This is a big risk that I have been warning about for months – we only need to see building approvals level out (even at high levels) for the contribution to growth from home building to decline to zero.
In the year to March, for example, home building (excluding renovation activity) in the national accounts grew by 16.3%, and directly contributed 0.5pp – or one fifth – of the 2.5% growth in the economy. That also ignored the multiplier effects associated with better activity in the related industries of transport and manufacturing.
Annual growth in home building slows to 10.4% in the year to June and we already seem close to a peak in this source of economic growth.
For what is worth, Alan Mitchell of the Australian Financial Review – a noted RBA Watcher – jumped off the fence unusually early, by suggesting this week “there is now a very good chance that the Reserve Bank will cut interest rates next month.”
Mitchell is not normally this forthright this early, suggesting his views and been especially well sourced.
If so, a rate cut would be consistent with my long-held view that the RBA will eventually be required to cut official interest rates to 1.5% by mid-2016. Indeed, should the RBA cut next month, it will do so even before the unemployment rate – which has been broadly stable for much of the year – has started rising again. My view is that the sluggish state of the economy will eventually push up the unemployment rate to 6.5% by early 2016 – suggesting the RBA will be under even more pressure to cut interest rates again.
Of course, the big losers in all this are depositors. Banks, after all, are raising lending rates to preserve profit margins in face of the higher capital costs associated with providing loans. To the extent the RBA wants to have banks lower their lending rates back again – to a level the RBA prefers – it does this by cutting the official cash rate, which effectively lowers the cost of short-term funding that Banks face. That’s because the cash rate affects the cost of short-term wholesale financing, and ultimately the yields available on retail deposits.
So contrary to some reports, it’s not true the RBA has lost control of the interest rates the Bank can set. Due to its ability to set the official cash rate, the RBA still have a major influence over Bank funding costs, and hence the level of lending rates that are competitively set in the market.
