Down, down, interest rates going down in 2013, but will they make a difference?

That annoying Coles jingle “Down, down, prices are down” (was there ever more reason to shop at Woolworths?) could easily be applied to the outlook for the cash rate in 2013 with economists revising their forecasts in expectation of further rate cuts over the course of the next 12 months.

The key questions remain how many more rate cuts there are likely to be in the current cycle and perhaps more importantly, if they will have any impact on buying intentions of key market segments like first-home buyers and upgraders.

Certainly rate cuts will be welcomed by the generally financially better off investor market, where activity already appears to be on the rise based on October housing finance figures from the ABS.

These showed a 5.5% rise in the value of fixed-rate investor home loans over the month of October, compared with 0.2% decline in the value of owner-occupier mortgages.

An improvement in the new housing market is also expected, with Westpac chief economist Bill Evans noting that residential construction sector has “turned the corner and will be supported by recent lower interest rates, a shift which has greatly enhanced housing affordability” as well as from the  $15,000 first-home buyer handouts for those buying or building a new home in NSW and Queensland.

Evans quotes ABS construction figures that show that new dwelling construction advanced by 3.7% in the September quarter, partially reversing a 7% decline over the previous five quarters.

In addition, he points to the October Westpac- Melbourne Institute consumer sentiment index, where the ‘time to buy a dwelling’ sub-index showed a very positive response rising to the highest level since late 2009.

“This suggests that a housing recovery is locked-in for 2013. However, we expect the upswing in activity to be relatively gradual to emerge and that the cycle will be restrained by historical standards. The main constraint is the high starting point for household debt. Our forecast is for new dwelling construction to rise by 4.5% through 2013 and by 5.0% through 2014,” he says.

However, the evidence of a recovery is less certain for established housing, which makes up the bulk of the Australian housing market.

Concerns remain about the fragile confidence of Australian consumers, with the November Westpac consumer index recording a drop in confidence to levels last seen before the RBA began cutting the cash rate in November last year, though mortgage holder confidence rose 4.4%.

The key take-home message from the November index were concerns about the economy and job security are upper-most in the minds of consumers, something a rate cut won't easily fix.

Despite 175 basis points being trimmed from the cash rate since November 2011, consumer confidence has not improved, with interest rate cuts appearing to lose their potency, a point observed by Laing+Simmons general manager Leanne Pilkington who, following the December rate cut, said they were no longer having any meaningful impact on housing market activity.

For the RBA, the focus will be on the job market and the non-mining sectors of the economy, including housing, taking up the slack with the 2014 mining investment peak now “confirmed”.

“Labour demand had softened, which pointed to only modest employment growth in coming months,” was arguable the key sentence in the December minutes, along with the RBA’s note that the “inflation outlook still afforded the board some scope to provide additional support to demand”.

ANZ has revised its estimates and is now tipping a further 100 basis points to be shaved off the cash rate over 2013, principally due to the slowdown in mining investment and an expected slow pick-up in non-mining sectors.

This would take the cash rate to an unprecedented 52 year low of 2% and could result in introductory variable loans being offered at around 4.4% (currently the cheapest variable loan offerings start from about 5.2%) assuming lenders pass on about 80 basis points to borrowers.

Standard variable mortgage rates would fall to around 5.6%, while the three-year fixed rate would fall well below 5%.

AMP Capital chief economist Shane Oliver is tipping at least two more rate cuts next year (in February and April), taking the cash rate to 2.5%, but warns that the cash rate could fall below 2% if the recovery in key non-mining sectors like retail, housing and tourism is slower to eventuate.

According to Oliver, in the current environment “of household and business caution post-GFC” the neutral standard variable rate has likely fallen to around 6.75%.

“In the last two easing cycles the mortgage rate had to fall to around 6.05% in 2002 and to 5.75% in 2009.

“Given the fall in the likely neutral level for mortgage rates and the current headwinds coming from the strong Australian dollar and fiscal tightening, mortgage rates will at least need to fall to these lows.

“Given ongoing issues with bank funding, to achieve a circa 6% mortgage rate the cash rate will need to fall to around 2.5%,” he says.

Oliver is quite bullish on the impact that lower rates will have on the housing market.

“Based on the assumption that the RBA cuts interest rates further and the global economy stabilizes then Australian economic growth should pick up by the end of next year.

“One should not underestimate the boost lower mortgage rates will ultimately provide. A fall in mortgage rates to 6% from the 2011 high of around 7.8% is equivalent to around $4500 pa in interest savings on a $300,000 mortgage. Ultimately some of that will be spent.

The key question remains though if lower interest rates will have enough of an impact on the housing market to spur a pick-up in activity.

Westpac’s Bill Evans anticipates one more rate cut on February 5 when the RBA next meets, but tellingly adds that “evidence to date is that low rates are not achieving traction with the hearts and minds of households or business”.

But he says the RBA is unlikely to concede that its primary policy instrument is ineffective.

However if the cash rate does fall to 2% and bank mortgage rates follow downwards but home buyers stay away, the uncomfortable question for the RBA and economists will be: where to next?