House prices, iron ore and Australian leave RBA grappling for answers

When it happens, the cut will amplify questions about how low the Reserve can safely and usefully go.

When it happens, the cut will amplify questions about how low the Reserve can safely and usefully go. Photo: Reuters

If the Reserve Bank of Australia decides to slice another quarter of a per cent off interest rates on Tuesday we can thank the recent fall in the iron ore price to under $US50 and the stubbornly resilient dollar. If the RBA leaves rates on hold at 2.25 per cent the nation can blame Sydney’s residential property buyers, whose demand has contributed to a sizzling-hot house market.

Tuesday’s rate outcome is keenly anticipated. A cut in rates is expected to result in a boost for the stock market and a fall in the Australian dollar. The maintenance of the current rate would have the reverse effect.

Of course it is not as simple as Sydney property versus a 10-year low in iron ore prices or even the dollar. However, these three features are seen as extreme or potential tipping points in the RBA’s direction on interest rates this week.

Since the March decision to keep rates steady at 2.25 per cent there has been a scarcity of important economic data, and the all important inflation numbers are not due out until later in April.

Nor have there been any wild swings in the fortunes of the global economies that would have a major influence on the RBA’s decision.

Economic growth remains limp and employment trends continue to weaken slightly.

However, nothing monumental has taken place in Australian since February, when the interest rate was dropped by 25 basis points, except from the fall in iron ore prices and continued strength in Sydney’s residential property market.

And bear in mind that the housing bubble around Australia is now deflating in a very ordered way – in all areas other than Sydney, where it continues to rise at alarming levels.

Leading up to the Easter break futures markets were factoring in a 75 per cent chance of a rate cut in April.

Traders are also putting the chance of a rates moving down to an unimaginable 1.5 per cent by August at 50 per cent.

Economists are not that certain. While almost all are factoring in another cut in the first half of this calendar year, many think it won’t come through until May or June.

The RBA has been pretty clear already that it is not yet finished this chapter of the monetary easing cycle – its just a matter of when.

It cites the economy’s growth rates as one of the main drivers for its view that interest rates must continue to fall despite the fact that they are already at historic lows.

The RBA would also like to see the Australian dollar undergo another reasonable fall this year.

The most obvious reason for the RBA to hold off another month would be a fear of further fuelling Sydney property prices or reigniting housing demand in other capital cities.

But it is probably not enough to offset the numerous other factors weighing in favour of a rate cut in April.

While there is always a lag between applying monetary stimulus and its effects being felt in the wider economy, the fact remains that Australians have been the beneficiaries of historically low rates for a few years and other than the property market there is not a lot of evidence that the previous rates cuts have found much traction.

Lower rates have not to date kick started a meaningful improvement in consumer confidence, and business investment remains lacklustre.

Borrowers will clearly have more money in their pockets if interest rates are lowered. (And their cash flow has also been recently bolstered by a fall in the price of petrol.)

However, those with investments in products such as bonds or bank deposits will suffer lower yields.

Perversely, the latest survey by Dun & Bradstreet on business expectations shows there was a lift in the number of firms intending to hire staff in the June quarter. This was despite the survey finding that fewer businesses were anticipating increased sales or profits, in an economy subdued by continued below-trend growth.

“The one relatively bright point is the continued, moderate increase in employment expectations, which is likely linked to record low wages growth rather than a strengthening in economic conditions,” Dun & Bradstreet’s economic adviser Stephen Koukoulas said.

Thus, on balance the case for a rate cut sooner rather than later stacks up. The fear of the effect on residential property is insufficient, according to economists, to justify not lowering rates.

Those buying in the Sydney market as an investment are now taking an increasingly large risk, with rental yields softening to about 3.3 per cent. The prospect of capital gains must become more tenuous as the prices rise.

The supply-side increase must ultimately start to kick in given we are witnessing record levels of construction approvals for dwellings.

If this doesn’t work, the regulators can further sharpen their macro-prudential tools to combat riskier borrowing.

Basically there are numerous ways to tackle the rising value of Sydney property, but little the RBA can do other than employ interest rate policy to counteract the effects of an iron ore price that is falling faster than the dollar, thus creating a stiff headwind to economic recovery.

source:smh.com.au

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