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Rate cuts and property prices

The Reserve Bank of Australia has long said it was maintaining a watching brief on the Australian (and, indeed, global) economy and would take action if needs be. Well on Tuesday 3 February it took action.

For the first time in 18 months, rates moved. The RBA cut the target cash rate by 25 basis points to an historic low of 2.25 per cent.

And while it’s great news for borrowers and will no doubt help elevate consumer sentiment, it must be remembered the key reason the central bank has cut the official cash rate is because the Australian economy is sluggish.

So what’s the reason for the cut? Put simply, lower growth, lower employment, lower inflation and lower commodity prices.

In his statement following the February Board meeting, RBA governor Glenn Stevens said available economic information suggests that growth is continuing at a “below-trend” pace with domestic demand growth “quite weak.” He also pointed out that the unemployment rate has moved higher while the decline in terms of trade, such as the fall in commodity prices, has led to a reduction in income growth. In addition, the consumer price index has recorded its lowest increase for several years.

“Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.”

The Reserve Bank anticipates slightly lower underlying inflation in 2015 than it had forecast in November last year, seeing it now at between two and three per cent rather than between 2.25 per cent and 3.25 per cent. This lower inflation outlook reflects “a fall in oil prices and [the] slightly weaker near-term outlook for product and labour markets which more than offset the upward price pressures from further exchange rate depreciation,” the central bank said.

Unemployment is also expected to rise further and peak later than expected, as spare capacity in the labour market has increased.


Commodity prices creating uncertainty

A clearer reason for why the Reserve Bank cut the cash rate came with its quarterly Statement on Monetary Policy (SMoP). High on the list were the effect of falling iron ore and oil prices, with the RBA noting the impact on economic growth of such falls was mixed, but the impact on the budget from falling commodity prices was overwhelmingly negative.

“Moreover, the outlook for commodity prices is a key source of uncertainty for both the global and the domestic economies,” the Bank said in the SMoP.

The RBA also highlighted the fact that non-mining business investment has been subdued over recent years, with recent data suggesting it will remain so into the first part of 2015.

The weakness in the Chinese property market is also noted as an ongoing source of uncertainty for the growth in China’s demand, including for some of Australia’s key commodities. “Moreover, the outlook for commodity prices is a key source of uncertainty for both the global and the domestic economies,” the statement said. “The outlook for the exchange rate is also an important consideration for both the global and the domestic economies.”

After the RBA’s announcement it was cutting rates, the Aussie dollar fell more than 1.5 per cent to below $US0.77.

In its SMoP announcement, the RBA said: “Most estimates suggest that the Australian dollar remains above its fundamental value, given the substantial decline in commodity prices over the past year. Increasingly divergent monetary policies in the major economies are likely to continue to have an important bearing on exchange rate developments.”


Spotlight on residential property

One sector that’s expected to receive a significant boost from the interest rate fall is the residential property market.

Home loan affordability

Dr Asti Mardiasmo, national research manager with PRDNationwide, says the cuts will have an impact on home loan affordability, with the potential to continue to rise in states such as Queensland, Tasmania, Western Australia and South Australia.

“However [it will] plateau for places like NSW and Victoria due to price growth and foreign investor activity,” Dr Mardiasmo says. “I say plateau, as certain buyers, such as first home buyers, may be priced out by the increasing level of local and foreign investors (particularly local, as foreign investors don’t necessarily borrow from our banks) who believe now is a great time to be able to afford investment properties.”

Overall, Dr Mardiasmo expects home loan affordability nationally to increase.

“Basically the lowering of interest rates can make people believe residential property should be more affordable now for owner occupiers and first home buyers, due to lower deposit and loan repayments; however this needs to be treated with care, as we are yet to see how the investment side will react.”

The RBA interest rate cut may also drive greater interest in satellite cities and outer ring areas as capital cities become less affordable for some, particularly first home buyers, Dr Mardiasmo adds.

This will result in greater urbanisation of these areas through their demand for services, commercial goods and connectivity to central business districts.

It’s a sentiment reflected by the RBA, which said it would continue to assume the wealth effect from higher property prices would lead to higher consumption, particularly if house prices increased in regions where appreciation had been more modest – particularly outside of Sydney.

Housing Commitments

On housing finance commitments Dr Mardiasmo believes these will continue on an increasing trend, for both investment and owner occupier purposes. For total residential building works she says we are already on an increasing level, so the lower interest rates will see this increase absorbed by the market at a quicker rate.

Residential Building WorkAnd while there was a softening of the dwelling price index in some capital cities in 2014, she expects the lower interest rates have the potential to reverse this.

But despite the massive focus on interest rates, they’re not the only factor to take into consideration.

House price index

“You also need to consider other factors such as the exchange rate, real wage rate (and whether or not there is a real increase), inflation rate and many others,” Dr Mardiasmo concludes.

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Lisa Llewellyn

Lisa started her working life as a property and financial journalist, working for media outlets including BRW, Radio 3AW and Australian Investment magazine. She turned her hand to PR and opened a boutique PR consultancy in 2001.

The opinions expressed in this article are the opinions of the author(s) and not necessarily those of Homeloans Ltd.