Interest rates heading down in December 2011: Westpac

Westpac expects the RBA to cut interest rates by 25 basis points in December, with further cuts expected during 2012 to take the official cash rate down to 3.75% by 2013.

The bank’s expectations are more conservative than interest rate markets, which it says are pricing in a 25-basic-point rate cut by October and a 50% chance of a follow-on move by February next year.

The bank is not alone in its dramatic shift in interest rate expectations.

ANZ now also expects the RBA will not need to raise the cash rate again before early 2012 and says the market is now pricing in rate cuts in 2011 – “a dramatic change from a couple of weeks ago”.

The expectation of a freeze on rates is based on a “bigger than anticipated loss of momentum in the non-resource sectors of the economy and especially in the labour market”.

The change in sentiment follows the release of the Westpac-Melbourne Institute Consumer House, with its price expectations index falling sharply from 37.8 in April to 15.3 in July.

Although most consumers still expect prices to rise over the next year, consumers are much less positive, with the index at its lowest level since May 2009.

Overall, 42% of consumers expect house prices to rise over the next year – the proportion of optimists dropping below the 50% mark for the first time since May 2009, when it came in at just 33%.

Just over 32% of consumers now expect prices to remain steady, with 26% expecting declines – up from 17% in April and the highest proportion since May 2009 when just over a third of consumers expected price falls.

"Consumers haven't turned pessimistic on prices but the shift in momentum bears close attention given the fragile consumer mood more generally," Westpac senior economist Matthew Hassan told The Sydney Morning Herald.

Westpac says the first rate cut is likely to be influenced by offshore factors.

“The catalyst for the first move is likely to be further adverse developments in Europe and their knock-on effects on global financial markets. Among the many other side-effects will be an ongoing negative impact on business and consumer confidence in Australia that is likely to become more pervasive as conditions deteriorate,” writes Westpac chief economist Bill Evans in the bank’s latest interest rate bulletin.

“I recently visited fund managers and central banks in Europe and could not find anyone who expected the current crisis to be resolved without an extended period of financial market turmoil.”

However, he does not expect the cut to be a one-off.

“Interest rates are too high in Australia, given the state of the non-mining sectors of the domestic economy, and a downward adjustment is required to avert a damaging round of contraction. This rate adjustment is likely to take a similar form to previous easing cycles,” he says.

There have been three easing cycles since the deep recession of the early 1990s:

• July 1996–July 1997 (–250bps);
• February 2001–December 2001 (–200bps) and
  September 2008–April 2009 (–425bps).

“These cycles were short and sharp and delivered a considerably larger cumulative cut than we envisage in the current circumstances,” he says.