Over the past six months the market has increasingly been conditioned to anticipate further rate cuts following downgrades in both the growth and inflation outlook. The futures market has priced in 50 bps of rates cuts from the Reserve Bank of Australia (RBA) before year-end to take the official cash rate to a new historic low of 1%. Of note, the last rate “hike” was nearly nine years ago, November 2010 when rates were increased to 4.75%.
Australian households have slowly come to terms with the low interest rate environment over a number of years now. Cash rates have been at historic lows since the last rate cut in August 2016 and this has been an unusually long period of steady rates. Further, the low rates impact both borrowers and savers for obvious reasons. With more rate cuts coming some investors will be forced to search elsewhere and take on additional risk for return. As for the deeply indebted borrowers, it will be some respite as they can continue to pre-pay their mortgages at a faster pace.
This of course assumes that banks will pass on all, or some of, the rate cut for borrowers. One would expect a portion of the rate cut to be passed on to enable the banks to protect them from the current margin squeeze. This will no doubt leave them in the firing line regarding optics as we are in an election year and politics is after all a brutal sport. Further, a delay in passing on the rate cut will also be a PR challenge for the banks who have been dealing with multiple challenges at once. The banking sector Royal Commission we “had to have” has delivered some unintended consequences.
Domestic economic activity has also slowed reflecting the global growth downgrades since October 2018. Business conditions have been notably softer this year after holding up well in recent years. The key exporting sectors (resources and some services such as education and tourism) and infrastructure investment (both private and public sector) are holding economic activity up and replacing some of the housing sector weakness.
At the consumer level, sentiment remains weak which has been reflected in the lack of large item purchases on the back of some negative wealth effects from the softening property sector. Despite wages actually growing ahead of inflation (CPI) on an annualised basis, the narrative does not reflect this, partly due to the lag in the recovery of wages to corporate earnings. Further, the scope for significant wage rises in a low inflation world is an issue for key developed economies globally. That is why lower mortgage payments (via rate cuts) combined with tax cuts can be an effective way to deliver household income growth.
There are some clear policy challenges ahead. The weakness of the housing market is the critical segment of the economy that needs to be managed. The RBA has engineered over many years the required slowdown it was looking for. Initially via stricter prudential standards to property investors and non-Australian residents back in the 2014-16 period. Post the banking sector Royal Commission the access to credit for new, or refinancing, loans has become significantly tighter. The one key positive is that the labour market remains tight for now.
With lower cash rates ahead, combined with some careful monitoring of the housing slowdown from the RBA, the domestic economy can steer through some key risks. Global growth is now at the slowest pace since the GFC. This will impact the degree of recovery and demand for our exports. The lower cash rates are part of the required policy to help steer our economy through a slower growth outlook. It will help those with a mortgage to service. For retirees, that unfortunately means lower term deposit rates ahead.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)
As seen also in Herald Sun, Thursday May 9, 2019.