The Reserve Bank of Australia has kept the official cash rate at a record-low 1.5% since August 2016, but the continued slowdown in the housing market has led some analysts to predict a rate cut.
According to AMP Capital Chief Economist Shane Oliver, the housing downturn – both in terms of slowing construction and falling house prices – will detract from economic growth to the extent that an interest rate cut will be needed to protect the RBA’s inflation target.
He argues this is because house price falls lead to what is known as the “negative wealth effect”.
Applied to the property market, the theory states that people spend less when house prices fall, as they perceive that their wealth has declined.
“That’s the main threat,” Oliver tells realestate.com.au. “And that leads to weaker consumer spending, which has the impact of keeping price inflation lower for longer. [Conversely], when property prices were rising in the past, people were happy to spend more and save less, despite lower wages.”
Morgan Stanley also predicts a rate cut. The investment bank argued in a recent report that house prices would likely drop by twice as much as initially forecast, to 15-20% below peak values, and that the RBA would therefore be under pressure to raise rates, to reverse declining consumer spending.
However, realestate.com.au’s Chief Economist Nerida Conisbee believes that while a weaker than expected economic performance in the third quarter of 2018 led the inflation rate to drop to 1.9%, there wasn’t enough data to support cutting the official cash rate.
“The inflation rate’s fall below 2% is one of the reasons some commentators have speculated that the RBA may soon cut the interest rate. But [when the inflation rate drops below 2%], it isn’t an automatic response from the RBA to cut the rate; they also look at the outlook as to where inflation will head without their intervention,” says Conisbee.
“Although we had a weaker than expected GDP result in the September quarter and consumer sentiment is low, unemployment is also low. The data out there is too mixed to make a move on rates.”
Persistent increases in short-term money market interest rates might, however, also influence the RBA’s decision.
The big four banks source roughly 20% of their money from short-term money markets, and the overseas funds have become increasingly expensive to access, cutting into the banks’ home loan profit margins.
Higher mortgage rates, however, would have a negative impact on consumer spending, as well as the RBA’s inflation target and the country’s economic performance more broadly.
According to Oliver, it’s another reason why the RBA might cut the official cash rate.
“The Reserve Bank might say, ‘well, we don’t want mortgage rates to go up, because that will affect the economy, therefore we will cut the cash rate with the aim of bringing down the debit rate and offsetting the increase in funding cost that the banks have experienced,” he says.