Banks expect rate cut soon, but no 2008-style cutting spree

Ahead of the tomorrow’s RBA interest rate meeting, the major banks are playing down the likelihood of deep rate cuts in 2012 as occurred during the late stages of 2008 when rates fell by 300 basis points in the space of four months.

Westpac and ANZ expect the RBA will cut rates tomorrow from 4.5% to 4.25% with the weak housing sector identified by Westpac as requiring “urgent action”, while the Commonwealth Bank expects the central bank to hold off until February as European concerns ease following the latest budgetary moves in Italy.

NAB expects the RBA to keep the cash rate on hold at 4.5% with a 25-basis-point cut in February although it says the probability of a rate cut in December has heightened.

Less than 15% of economists surveyed by Bloomberg and the Commonwealth Bank expect the cash rate to drop below 4% by the end of 2012, with more than 55% expecting the cash rate to settle between 4.25% and 4.5%.

Consumers appear to be in agreement with economists, with demand for fixed-rate mortgage products – in some cases a whole percentage point lower than lenders’ variable rates – continuing to rise. 

According to November figures from Mortgage Choice demand for fixed-rate loans have reached their highest level since April 2008, accounting for 20% of all new loan approvals up on the six-month average of 16%, the 12-month average of 14% and this period last year, when only 11% of new loans were fixed-rate loans. 

The cycle of fixed-rate cuts has continued, with Heritage Bank today announcing it will cut the interest rate on its three-year fixed-rate products from 6.29% to 5.95% Tuesday, December 6. 

Once again the Reserve Bank will have to way up the global situation and in particurlar Europe against a moderate strengthening in the local economy.

Westpac’s chief economist Bill Evans, the only major bank economist to tip a November cash rate cut as far back as August, still expects a further 75-basis-point rate reduction over the course of the current easing cycle, but says tomorrow’s decision is shaping up as a “tough one”.

“It will depend on the degree of urgency with which the RBA views global developments weighed against a policy stance already around neutral; the attraction of waiting to assess these developments; and evidence of an acceleration in mining investment but more weakness in the housing sector. 

“We see the balance of risks favouring another 25-basis-point rate cut,” he says. 

“Our assessment is that conditions have deteriorated significantly in Europe and Asia since the last board meeting on November. 

“Through November we have seen increasing acceptance by both private and public forecasters that Europe will be in recession in 2012. 

On the domestic front, Evans says the “two-speed” or “patchwork economy” is still very much in play, with the housing sector among the weak spots in the economy. 

“While most of the data still pre-dates the November rate cut, there have been no signs of stabilisation in house prices across most capital cities. Indeed, some corrections are now becoming quite advanced,” he says. 

“A particular standout was the very weak October dwelling approvals which contracted by 10.7% in the month including a 7.5% drop in private houses. These figures do point to a greater degree of urgency for RBA action. 

“Clearly there will be a significantly weaker profile in housing construction than we had thought; a 5% to 10% decline could take about 0.3 to 0.5 percentage points off GDP.” 

The release of third-quarter GDP figures a day after the December meeting will be closely watched by the RBA as a guide to future interest rate decisions. 

Westpac is forecasting GDP growth of 1.3% (up from its last forecast of 1.2%) equating to annual growth of 2.4% driven by a 36% spike in infrastructure work, but with housing construction expected to be flat compared with a range of 1% to 1.25% being forecast by the RBA and the Commonwealth Bank. ANZ is forecasting quarterly growth of just 0.7%. 

Commonwealth Bank chief economist Michael Blythe suspects the decision to cut rates in November is a close thing, indicating that “every [monetary policy] meeting is 'live' while the European situation plays out”.

Just four days ahead of the December 6 meeting, Blythe says the bank has pencilled in a February cut but said a December cut is still possible should markets turn sour.

Given the developments in Italy over the weekend with the Italian cabinet adopting $26 billion worth of tax hikes, budget cuts and pension reforms to avoid bankruptcy, from the Commonwealth Bank’s point of a view the chance of a rate cut has eased.

However, Blythe says economist and markets are in agreement that the next move is down, though “opinions differ on how far the easing may go".

“Global issues underpin the rate-cut case. Domestic issues suggest a need for caution,” he says.

Blythe points to RBA forecasts of underlying inflation picking up into the upper half of the 2% to 3% target range as well as national accounts should showing households “are a bit more focused on savings and paying off debt and a bit more cautious about spending”.

“Policymakers have spent a fair amount of time getting households to this point to make room for the mining boom to roll through. They are unlikely to want to jeopardise these changes by overstimulating the household sector. 

“A genuine European implosion would, of course, outweigh these domestic considerations in the policy debate,” he says. 

ANZ has brought forward its forecast of a 25 basis points cut in February 2012 to tomorrow’s meeting.

Ivan Colhoun, head of Australian economics and property research at ANZ, says “a lot still has to go wrong before market expectations for the cash rate to fall to 3% will be met”. 

“Global growth developments therefore support a further moderate easing in the Bank's policy stance, but to date still seem far from the dramatic and extremely negative developments experienced in the second half of 2008,” he says. 

NAB economist Alexandra Knight says the bank expects further easing in the underlying inflation rate in early 2012, but with inflationary pressure picking up over the second half of the year. 

“At this stage we're forecasting a 25bp rate cut to 4.25% in February 2012 to provide some near-term reprieve to interest-sensitive sectors, although this will be data dependant. 

“Given our expectation for higher underlying inflation in 2013, we expect the RBA to reverse any near-term rate cuts, taking the end point back to 4.75%.”

In a note released on October 26, the NAB economics team headed by chief economist Alan Oster said “market pricing, of around 100 points of cuts, is in our view too aggressive”. 

“While it is likely that the RBA will cut again in early 2012 (February), we would caution that that is not a done deal. 

“By then activity will be picking up and employment will be strengthening. Nonetheless, we have tentatively included a February cut in our forecasts very much driven by the near-term inflation outlook – we expect fourth quarter underlying inflation (due late January) to rise a modest 0.6% with the year ended rate unchanged at 2.5%.”