- 5 Jul, 2017

Rates on Hold, But Has Anyone Told The Banks?

RBA leaves the official cash rate on hold at 1.5%.

This decision was based on:

More economic data required to determine Australia’s stability;

A high debt-to-income ratio; and

The housing market being one to watch so it doesn’t become over-heated.

The Australian housing market’s renewed growth continues to put pressure on monetary policy. As a result, Australian banks are raising rates independently to curb a credit rating loss with Standard & Poor’s the world’s leading credit agency.

A solution, say economists, is to increase the cash rate. But, the Reserve is hesitant until the economy has fully stabilised.

The Impact of Lowering the Cash Rate in 2016

In 2016, the Reserve Bank of Australia (RBA) made two cash rate decreases to boost the economy. By reducing borrowing costs in 2016, the RBA wanted to increase economic stability. Their reasoning was that Australian Prudential Regulation Authority lending restrictions would continue to cool an already abating housing market.

Subsequently, a rate decrease would not reignite the 2013 boom. However, data suggests that they may have been wrong. Now many economists feel rate reductions may have added fuel to an already smouldering housing market fire.

RBA Cash Rate Graph

Housing Market Conditions

Historically speaking, Australian capital city dwelling prices between January 1 and April 31, 2016, rose by 8.1%. Following the RBA’s May cut, over the last 10-months, housing price growth has increased by 10.4%. So, while the introduction of APRA’s speed limit on investment lending was beginning to take hold, the RBA injected momentum. Although, the RBA continued to say that rate cuts did not appear to have an impact on the housing market. While this was true at the time, as many of us know, for every action there is a reaction. Consequently, the proof is in auction clearance rates.

CoreLogic data suggests auction clearance rates in March hit 79%, compared to 72% 12-months ago. These rates are well above the 66% average recorded over 6-months to February 2015, before the 2016 rate cuts.

According to economists, January 2017 investor lending rates continued to rise. Successively, data recorded an annual increase of 8.8% over the last 3-months. Thus, economists now say they expect to see national dwelling prices continue to grow until a policy change occurs. Nevertheless, by increasing the official cash rate, the RBA will kerb investor interest, quell demand and ease housing pressures.

The Australian Economy

Therefore, while the Australian housing market is rekindling prior momentum, it seems the economy is also returning to healthy levels. Thus, the December 2016 quarter recorded one of its largest surpluses with high export volumes and rising commodity prices. Furthermore, on March 22, 2017, the manufacturing index jumped to its highest level in 6-years and was just one point below an 18-year record.

Accordingly, the economy is expanding faster than predicted with a 2.4% GDP recorded over 2016, instead of 2.0%. Still, it is likely the RBA will sit for another month or two before making any move.

Cash Rate Changes

Should the Australian housing market and economy continue to gain momentum, then the RBA will raise interest rates mid-year. At present, strong property prices and housing credit growth are encouraging the Standard and Poor’s to downgrade Australia’s triple-A credit rating. Though the RBA can reduce housing market heat with a rate rise, then the Standard & Poor’s should relent, with credit risk downgraded.

Given that Australian household debt-to-income ratio is much higher than previously, it’s likely any rate increase will be marginal. For instance, in 2000 the Australian debt-to-income ratio was 125%, in comparison today it’s 187%. Hence, when rates rise, increases will be gradual to keep consumer behaviour consistent.

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