Laura Akhurst - 1 Sep, 2015

RBA Leave Rates on Hold, But Another Cut is Likely this Year

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eChoice RBA Commentary for September  2015

The RBA have left the official cash rate on hold at 2.0 percent.

This decision was based on:

o Poor business investment;

o Weakening commodity prices;

o A higher than anticipated value for the Australian dollar;

o Shifts in monetary policy; and

o Continued home price growth.

After a turbulent end to August 2015, the Reserve Bank of Australia (RBA) has left the official cash rate on hold at 2 percent. But, economists and consumers are fairly confident that a rate drop will be on the cards for November.

On Monday August 24, global markets experienced a meltdown, share prices plummeted and billions were wiped from the stock exchange. This prompted consumers to question whether or not this was the beginning of another global financial crisis.

Economists, however, reassured those concerned that the markets had been over-inflated for some time and were going into a period of re-adjustment. The Australian stock market recovery that was witnessed on Tuesday 25 confirmed this. Many economists believe that the hit the Australian economy has taken from share drops will be too small and will not translate into weaker consumer and business investment demand. However, there are other factors that need to be considered.

The Chinese Economy

At present economists are more concerned with China and its economy, which can have a real impact on the Australian economy. But, in saying this, the economic slowdown being witnessed in China is not as volatile as the 1997 crisis. While the current slowdown in China has hurt Asian exports and the collapse of commodity prices has decreased market demand for Asian exports, many economists feel that growth won’t subside, and a financial crisis is unlikely. Given this, most economists are predicting that China’s economy will begin to recover in the second half of 2015.

The Australian Economy

Turning our focus back to Australia, many economists are suggesting that the nation’s economic growth is below longer-term averages and that the Australian economy has spare capacity, and will have for some time to come. Low interest rates and the fall in the value of the Australian dollar are assiting to rebalance the Australian economy so that sectors that were repressed by the mining boom are now able to regain strength. This has been noted in a recent comparative ranking study of the states and territories, as Western Australia, which was once at the top of the scale, has fallen to the lower end of the scale and New South Wales and Victoria have pushed their way to the top.

Annual Percent Change in State and Territory Rankings

State Retail Sales Building Approval Trend Final DemandReal Home Prices Jobs Jobless Rate Rank
N.S.W +6.7 + 22 +1.9 + 18.4 +2.5 5.8 1
VIC +5.3 +24 +3.3 +11.5 +3.0 6.0 1
ACT +7.4 +61 +2.4 +1.2 0.0 4.1 3
NT -0.2 -37 +5.4 -5.3 +3.8 4.5 4
S.A +6.1 -15 +2.7 +3.4 -0.2 8.2 5
TAS +1.7 +34 +1.7 +2.5 +1.3 6.5 5
QLD +3.2 +16 -2.1 +3.9 +0.6 6.1 5
W.A +2.5 -6 -4.9 -0.3 +2.3 5.8 8

Source: ABS, CoreLogic RP Data, AMP Capital

But it’s likely that the Australian economy is going to need more help to regain its momentum. This is why economists and consumers alike are suggesting that the RBA will make another official rate cut before the end of the year.

Economists’ reasoning for a drop in the official cash rate is based on a poor business investment outlook, weaker than expected commodity prices, and the Australian dollar remaining high, as well as Sydney and Melbourne property prices expected to slow, and monetary policy being tightened. Consumers, on the other hand, feel that the official cash rate will drop below 2 percent by the end of 2015 due to concerning economic developments and weaker domestic conditions.

Economists’ Reasoning

•  Poor business investment – According to the latest Australian Bureau of Statistics (ABS) investment intentions survey, released after RBA rate cuts in May, investment estimates fell by 25 percent.

•  Weaker commodity prices – Iron, coal, metals and energy prices continue to fall. This is mainly due to an increase in supply. This, in turn, has reduced Australian export prices.

•  The Australian dollar remains high – During a commodity slump it’s typical for the Australian dollar to fall below fair value. This fall is needed to help sectors affected by the mining boom to recover. These sectors include tourism, education, manufacturing and farming. But moderate US economic growth, weak wage growth and rising inflation is delaying the rise of US rates, and this is keeping the Australian dollar at a higher rate.

•  Sydney and Melbourne house prices are likely to drop – Moves by banks to tighten property investment conditions by introducing tougher income testing, lower loan-to-value ratios, and higher home loan rates due to APRA pressure will reduce investor demand. As a result, property prices in Sydney and Melbourne are expected to have a lower growth rate, which will remove a major barrier for RBA rate reduction.

•  Tightening monetary policy – Hikes in bank interest rates for new and existing property investors may be passed on to owner-occupiers as banks respond to APRA’s demand to raise capital to reduce property lending risk. This could slow economic growth further, which the RBA will be seeking to avoid.

Consumer Sentiment

A recent consumer poll, of over 900 home buyers, revealed that more than 60 percent felt that the RBA would cut rates in the near future, and the remainder said that the RBA would leave rates on hold. Interestingly, no respondents felt rates would rise.

According to the poll results, over 40 percent of the respondents said that the official cash rate will be lowered to 1.75 percent. However, a further 16 percent felt it could drop as low as 1.5 percent.

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