Australian interest rates April 2017
Australian interest rates: on hold 2017 & 2018, risks with over-regulation.
RBA holds rates steady ...
As universally expected, the Reserve Bank Board decided to leave the cash rate unchanged at 1.50% in April. As we anticipated, two key changes were prominent in the statement by the Governor.
Firstly, the commentary around the domestic economy was somewhat less upbeat. The growth performance was described as “ongoing moderate growth”. The commentary around the labour market was downbeat. In particular, he noted that some indicators of conditions in the labour market have softened recently; the unemployment rate has moved a little higher; employment growth is modest and wage growth remains slow.
... shifting focus to new regulatory initiatives...
Considerable attention is also given to the housing market, noting the risks associated with high and rising levels of indebtedness. The Minutes to the March meeting referred to “a build-up of risks associated with the housing market”. The Governor significantly raises the bar on the need for enhanced regulation asserting that lenders need to ensure that the serviceability metrics that they use are appropriate for current conditions.
With no flexibility to raise rates to deal with these risks the Bank and the regulator, APRA, have since announced some additional policies to curb growth in lending by limiting banks’ lending to interest only borrowers, effectively slowing loan growth to investors.
... aimed at containing build-up in leverage risk.
This approach of targeting investors is similar to the successful approach used in 2015 when house price inflation, on a six month annualised pace, slowed from 20% as at April 2015 to 0% in April 2016 in Sydney and 15% to 4% in Melbourne.
However, it seems unlikely that the recently announced measures will have the same impact on new lending to investors that we saw in 2015.
In the year to June 2015, new lending to investors reached $162 billion and fell 15% to $137 billion in the year to June 2016. To achieve a similar result in 2017, we expected that the new policy would seek to slow growth in the stock of lending to investors from the current 10% guideline to a 5% pace (current growth is around 8%).
Such policies worked well in 2015...
In 2015, direct controls were also supplemented by out of cycle rate hikes by the banks and a significant strengthening of micro prudential guidelines. The effective increase in the average loan rate across the mortgage portfolios of the 4 majors was an increase of around 27bps. Recently the banks have also increased rates on investor loans and owner occupier loans, although the effective average increase has been considerably less, at 17bps.
... expect further action by RBA and APRA.
Overall it is reasonable to conclude that the sharp slowdown in house price inflation in 2015 is unlikely to be repeated under the current set of policy and rate adjustments, although some moderation in price pressures can be expected.
Consequently, it is not unreasonable to assume that further action by the Bank and APRA can be expected. Indeed, the head of APRA has already alluded to possible increases in capital requirements for mortgages.
However, throughout this process of macro prudential tightening, care will need to be taken if the authorities want to avoid an unnecessarily sharp downside response in the market. Note that house prices can and do fall in Australia. Both Sydney and Melbourne house prices fell in both 2008/2009 and 2011/2012.
House prices have fallen on two recent occasions...
However, those falls were under the weight of cumulative mortgage rate increases of 155bps and 205bps respectively. The falls were subsequently reversed by RBA rate cuts of 425bps and 225bps respectively in the subsequent years. No such flexibility is available to the RBA now with the cash rate at only 1.5%.
But now compare the response of the market to the package of measures in 2015. Despite only a modest 27 basis point rise in mortgage rates, complemented by the macro prudential policies, house price inflation slowed very sharply in both Sydney and Melbourne (see above). This episode illustrates that the Bank and APRA do have tools available to cool the housing market.
... cushioned by RBA rate cuts.
The best and most likely outcome is a prudent application of the current policies and probably others that may or may not be publicly announced. That will help engineer a manageable slowdown in house price inflation without precipitating a dangerous over reaction in the housing markets.
I expect these policy developments to play out over the course of 2017. By year’s end official concerns about housing and household leverage will have eased. However, despite low inflation and ongoing slack in the labour market (unemployment rate forecast to remain around 5.75%) there will be no move to cut rates – 2016 taught the authorities that housing markets are very sensitive to official rate moves.
AUD to fall in 2018, boosting economy.
Instead the Reserve Bank will rely on a solid fall in the Australian dollar to provide the boost to the economy. We retain our call that official rates will remain on hold throughout 2017 and 2018.
Bill Evans, Chief Economist
Reproduced from the April 2017 edition of Westpac's market outlook
Business focus also has the following articles from the April 2017 edition of Westpac's Market Outlook;
Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.