The Australian cash rate has now been at the historic low of 1.5% since August 2016 and looks set to remain there for some time. This is due, in part, to weaker house prices. Financial markets continue to actively scrutinise the timing of the next move with implications for the economy and ultimately impacting the returns of your portfolio. Bottom line – it is too early For the RBA to raise rates domestically despite other global central banks raising rates this year.
While business conditions are trending well the challenges policymakers have is to engineer a soft housing landing. They also need to be mindful of the banks wholesale funding targets (and subsequent margin pressure) in this post Royal Commission regulatory world.
The benefits the Australian economy received from the very strong domestic big four banking system during the global financial crises (GFC) and credit crunch in 2008 is well behind us now. While it is an oversimplification, the strength of the big four bank system helped cushion some of the downside of the unforgiving GFC. However, this was also the reason they could not be such a dominating part of the economy going forward. Global funding costs for banks have been re-priced.
The demerger cycle of the major banks has been underway for a number of years. It started slowly and now the momentum has picked up with both regulatory and market reasons driving this agenda. The higher regulatory capital requirements for non-core banking business units and the higher cost-to-income were the early signs of this asset sale phase. Trustee businesses, wealth managers, fund managers, insurance and superannuation are just some of the areas the major banks have sold businesses in recent years. This will continue.
The higher wholesale funding hurdles for the banks have also created some challenges. To maintain their net interest margins, they are pressured into raising mortgage costs to borrowers outside of the official RBA rate announcement cycle. They need to pass on their higher funding costs otherwise they are not looking after shareholders. However, the banks will continue to have a balancing act with general sentiment.
The higher borrowing costs from the banks outside of the official interest rate cycle is a key reason why the RBA is limited. Raising rates now with the housing market cooling can significantly elevate risks for the housing market. The RBA has effectively engineered a slowdown of the housing sector from prudential regulation. Requiring changes to investor vs home borrower conditions, regulatory capital adjustments and capping non-domestic residents from obtaining access to mortgages have all helped slow down the housing cycle momentum in recent years.
This has now created some existing challenges for parts of the domestic economy. The RBA would be happy to see a soft landing in the main housing markets of Melbourne and Sydney given the very strong median house prices we have witnessed over the past decade when the GFC was at full swing.
Like the regulator, global investors have always looked at the Australian housing price boom with some concern. It is clear that prices could not accelerate at the rate they did and some consolidation is a good outcome for longer term stability. Further, the robust population growth for Melbourne over the past decade will unlikely happen at the same rate again.
Engineering a soft landing for the housing sector is not a simple task. Historically it has been a very difficult proposition for regulators. The RBA have over a number of years applied various prudential processes that have worked well to date. Increasing the official cash rate now, or in the next twelve months, would not be a prudent move when house prices are falling. The lower AUD will act as a cushion to the domestic economy. The RBA needs to remain alert and work diligently to ensure that investor confidence remains.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)