What if the RBA doesn't cut rates? Cameron Kusher

EXPERT OBSERVER

There is a wide-spread belief that Reserve Bank Governor Lowe’s speech on 21 May clearly indicated that the RBA are set to cut official interest rates on Tuesday 4 June when they next meet.

While I (and the interest rate futures market and the overwhelming majority of economic commentators) believe that is still the most likely outcome, I can see a scenario whereby the RBA once again keeps rates on hold.

People love to tell me that housing isn’t the economy, and they’re right it isn’t however, it is the largest single asset class in the country and thereby pretty important to the health of the economy. Over recent weeks there have been a number of changes that have been overall a positive for the housing market going forward:

There was no change of government at the federal election. Whether you believe that changing the rules around negative gearing and the capital gains tax discount would have a big impact on the market or not, those proposed changes did inject a level of uncertainty into the market.

While the Labor Party was expected by most to win the election, the aftermath of a Coalition win seems to have seen a level of confidence returning to the market.

Dwelling value declines were already slowing but now lenders are reporting much higher levels of mortgage demand and auction clearance rates last week lifted to their highest level nationally since mid-May last year and in Sydney they increased to their highest level since April last year. 

APRA has signalled they are looking to change serviceability calculations on new mortgages.

Ultimately it will mean that some people that previously weren’t able to borrow will be able to and those that could already borrow will potentially be able to borrow more.

Again, these changes aren’t yet live but once implemented, easier access to a housing loan should support a lift in market activity and help to provide a floor under housing prices.

The RBA flagged that interest rates would be reduced. After official interest rates have remained on hold for 33 months, Governor Lowe dropped his biggest hint yet that interest rates will be reduced in June during his speech on the 21 May.

Interest rate cuts put more cash in mortgage holders pockets, if someone is struggling to repay their mortgage they can contact their banks and ask for a reduction in repayments (assuming lenders pass on a cut which is highly likely) and for those that choose not to reduce their repayments they end up paying back more of the loan principal thereby paying down debt quicker.

Furthermore, a lower cash rate typically means lower interest rates on savings accounts, thereby reducing the incentive to save and increasing the incentive to spend.

All three of those items are overall a positive for the housing market. It is important to note that items two and three have not yet happened so anyone now buying could have bought pre-election but chose not to.

To me that indicates a concern around policy changes proposed by the party perceived as most likely to win the election. So with the largest asset class looking more positive why would the RBA choose to cut now? It’s not a cut about housing it is a cut related to economic growth and inflation.

Headline inflation was unchanged over the March quarter and just 1.3% higher over the year.

The RBA’s preferred measure of underlying inflation was 0.2% over the quarter and 1.4% higher over the year, both drifting further away from the 2% to 3% target range. Underlying inflation has been allowed to sit below the target range since December 2015 and hasn’t hit the midpoint (2.5%) since September 2014.

Gross Domestic Product (GDP) or economic growth was recorded as 0.2% over the December 2018 quarter its lowest growth rate since September 2016. On an annual basis, GDP rose 2.3% which was its slowest rate of growth since June 2017.So we have low inflation and sluggish economic growth, which has been the case for some time but both have weakened further in their recent releases.

The RBA has repeatedly stated the main reason for not cutting interest rates is the strength of the labour market however, it has now also weakened. On a seasonally adjusted basis, the unemployment rate in April 2019 was 5.2% having risen for two consecutive months and the highest unemployment rate since August 2018.

Although the unemployment rate has risen, annual jobs growth has increased to 2.6%, its fastest growth rate since June 2018 and the workforce participation rate at 65.8%, the highest it’s been since January 2018.

So while the unemployment rate has weakened, more people are in work or looking for work and job creation has accelerated. We should note that unemployment is typically a lagging indicator and measures of job advertisements are showing slowdown over recent months.

Given all of this, I still believe than an interest rate cut on June 4 is the most likely scenario but I won’t be surprised if the RBA, which has taken a slow and measured approach to cash rate setting of late, is tempted to wait another month.

Waiting another month will allow the RBA to gather more evidence as to whether the housing market is truly improving and it will afford them the luxury of seeing the March quarter GDP figures which are released the day after their board meeting (June 5).

Another weak quarter of economic growth will surely trigger the need for a 25 basis point or even 50 basis point cut to the cash rate in July. Furthermore, by the time of the RBA’s July board meeting there will be another read on the labour force and if there is another monthly increase in the unemployment rate that surely constitutes a trend.