Tag Archives: interest rates

June 7, 2022 · 7:01 am

Households hold key to more rate hikes

How consumers respond to the challenging mix of rising living costs and higher interest rates on one side and a strong labour market and increasing wages on the other will go a long way to determining how tight the Reserve Bank fo Australia turns the monetary policy screw.

In his statement announcing a 0.5 percentage point increase in the cash rate to 0.85 per cent, Reserve Bank Governor Philip Lowe made it clear that interest rates will rise further, saying, “The [RBA] Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead”.

Mr Lowe says he expects inflation to ease next year back within the 2 to 3 per cent range which is the central bank’s target band. But this is predicated on more rate rises.

The only question is how high interest rates will need to go, and how fast.

Internationally, a lot will need to go right if rate rises are to be modest.

The extreme pressure on global supply chains of food and energy will need to ease and commodity prices stabilise. This will involve many countries currently affected by the supply shock caused by the Ukraine War being able to find alternative suppliers. It will also require food and energy exporters to be able to increase their production, something that climatic conditions and transport systems could impact on.

China’s response to COVID-19 also remains a key point of uncertainty. Though Shanghai is emerging from lockdown and restrictions in Beijing are not as tight for now, as long as China sticks with its Zero Covid policy more lockdowns are a real possibility.

Even if international conditions improve, how Australian households behave over the coming months will be crucial.

Though many households have built up savings and those with equity in the housing market have experienced a significant increase in asset wealth, how they respond to rising prices and interest rates will be telling.

The RBA’s central case is for strong consumption growth this year as many consumers, buoyed by strong savings, high house prcies, a tight jobs market and rising wages, feel comfortable enough to splurge.

If they do, it is likely to mean interest rates will have to go higher than they might otherwise.

But there are good reasons to think that many will act more cautiously. Renters, those on low incomes and those carrying big mortgages, in particular, may all feel good reason to keep a tight rein on spending.

As the Reserve Bank Board deliberates on further rate hikes over coming months, retail spending, household borrowing and credit card statistics will be among the key indicators it will be keeping a close eye on.

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May 7, 2022 · 5:45 am

It (still) all comes back to productivity

Amidst all the discussions of this week’s interest rate rise and the outlook for inflation, wages and growth, one crucial factor has been largely overlooked: productivity.

It’s an ugly word and can be very tricky to measure.

But it is likely to play a crucial role in how high interest rates go and how well-off we all become.

Productivity is basically a measure of how much is produced for a given level of input (labour, capital and other resources).

When he was Treasury secretary, Ken Henry regularly referred to productivity as one of the three Ps crucial to growth (the others being population and participation).

Productivity is especially important in a high-inflation environment like we have right now. The more that can be produced using a given amount of labour and capital, the cheaper it is to produce.

If there is sufficient competition, this will tend to put downward pressure on prices.

The big problem is that for the 25 years productivity growth in Australia has been mostly weak.

Analysis by the Australian Bureau of Statistics shows that in that time both labour productivity and so-called multifactor productivity (that is, productivity including labour, capital and everything else) has mostly been below 2 per cent.

The last time it reached above that was in 2014-15.

This brings us to the Reserve Bank of Australia’s latest assessment of the economic outlook, which came out on May 6.

In it, the central bank lays out its central case for how it thinks things will turn out.

Broadly, it expects inflation to rise to 6 per cent by the end of the year and only gradually ease back to 3 per cent by mid-2024.

It thinks unemployment will remain low (3.5 per cent), forcing wages and other inducements like bonuses and overtime payments to accelerate to around 5 per cent by mid-2024.

This will support household consumption and growth.

This is what the RBA thinks is the most likely scenario.

But the central bank’s quarterly outlook always includes a section that looks at all the things that could go wrong.

Right now, it is quite a long list – another serious COVID-19 outbreak, ongoing disruptions to global supply chains and tumbling house prices, to name but a few.

But one of the crucial unknowns is productivity.

If it improves significantly, inflation could ease more quickly and real incomes (adjusted for inflation) could grow, boosting prosperity.

There is some cause for optimism here.

Business confidence has increased in recent months and firms are ratcheting up their investment plans. Capital investment has been the most important driver of productivity growth in the most recent cycle, according to the ABS, so the increased willingness of businesses to buy new equipment and technology could deliver an important productivity boost.

But there is ample scope for things to go wrong, as the RBA has acknowledged.

“It is possible that some of the recent changes in spending and production patterns are long-lasting and that these constrain the efficient allocation of resources and, in turn, productivity,” it said.

If that turns out to be the case, then “any given rate of growth could be more inflationary than before the pandemic”.

And if wages increase in the absence of an improvement in productivity, the consequent boost to household spending will likely result in “inflation being sustained at a higher rate than currently anticipated”.

That would inevitably mean that interest rates have to go higher for longer.

So boosting productivity will be key if the nation is to avoid high interest rates and cost-of-living pain.

There are plenty of things that governments can do to help achieve this, like ensuring a welcoming environment for investment (local and international), encouraging greater workforce participation through measures like improving access to affordable child care and investing in education.

For the past decade, progress on any of these has been woeful, and in several cases has gone backwards.

Whoever wins the election needs to make enhancing productivity a top priority.

Our future prosperity depends on it.

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May 6, 2019 · 12:00 am

Interest rates Australia: the outlook for 2019

This post was first published in In The Black on 8 March 2019 at https://www.intheblack.com/articles/2019/03/08/interest-rates-australia-outlook-2019

When the Reserve Bank of Australia (RBA) last changed interest rates Malcolm Turnbull was still prime minister, Donald Trump had yet to seize the White House, the UK had just voted for Brexit and house prices were booming.

During all the subsequent turbulence locally and abroad, the RBA cash rate has been a rare constant. In two and a half years it has not budged from a record-low 1.5 per cent.

However, markets and economists increasingly believe this period of policy stability is coming to an end, though views diverge sharply on whether the next move will be down or up.

The Reserve Bank recently indicated that it has shifted from a bias towards increasing interest rates to a more neutral stance. Governor Philip Lowe said in a recent speech that “over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced.”

Unemployment falling

CommSec senior economist Ryan Felsman.

Some, such as CommSec senior economist Ryan Felsman (left) and ANZ’s co-head of Australian economics, Cherelle Murphy, think the time is coming when the RBA will be able to raise interest rates.

Despite weakening house prices, the employment rate was steady at 5.1 per cent in January, supported by strong participation in the labour force, according to the Australian Bureau of Statistics. The trend ratio of employment to population rose to a 10-year high of 62.4 per cent.

Felsman says the central bank will look past the continued slide in house prices and unexpectedly soft growth in the September quarter to developments in employment.

“The labour market is the key indicator going forward as far as interest rates are concerned,” he says.

Demand for workers has been building – about 284,000 jobs were created in 2018 and the unemployment rate has dipped to 5 per cent – and Felsman expects this pressure to gradually force wages higher and enable households to increase their spending.

Eventually, he expects wages growth to reach 3.5 per cent, which would be consistent with an inflation rate of about 2.5 per cent – the mid-point of the Reserve Bank’s 2 to 3 per cent target band – “which the RBA has previously identified as a level they would like to get to before they lift interest rates”.

Interest rates to rise in November?

ANZ’s co-head of Australian economics, Cherelle Murphy.

 

Felsman thinks this point will most likely be reached in November, convincing the central bank to lift the cash rate to 1.75 per cent.

Murphy (right) shares Felsman’s upbeat outlook for the economy but foresees a more gradual improvement.

She does not expect the RBA to lift the cash rate until August next year, followed by another increase in November 2020 to take the cash rate to 2 per cent.

Murphy says national income is holding up. Businesses are being buoyed by good profits, encouraging them to invest and hire, and feeding more company taxes into government coffers.

Just as important, tighter credit conditions are working to cool the once-rampant property market without triggering widespread mortgage defaults.

While homeowners may see a peak-to-trough fall of 20 per cent in house values before the market stabilises, Murphy says the fact that mortgage rates are stable means few are being forced to sell.

“This helps explain why consumer confidence has not fallen in a hole, and instead has stayed at pretty high levels,” she says, along with the strong jobs growth.

Given the importance of private consumption for economic activity (accounting for almost 60 per cent of GDP), this is an important plus for growth.

Further interest rate cuts

AMP Capital Markets chief economist Shane Oliver.

 

AMP Capital Markets chief economist Shane Oliver (left) and Market Economics principal Stephen Koukoulas are much gloomier about the economic outlook and believe tepid growth, elevated global risks and inflation that is stubbornly below target will leave the Reserve Bank board with no choice but to cut official interest rates in 2019. Oliver tips the rate to drop to 1 per cent by the end of this year; Koukoulas reckons it will hit a record low 0.75 per cent.

Both forecasts are more aggressive than financial market estimates which, which nonetheless have fully priced in a rate cut to 1.25 per cent by the end of the year.

Concerns about growth, falling house prices, stagnant wages and soft household spending have been underlined by the release of figures showing underlying inflation has been below the RBA’s 2 to 3 per cent target range for most of the past four years.

China’s slowing economy

Internationally, China – Australia’s largest export market – has slowed. In the 12 months to the December quarter it expanded by 6.4 per cent, its weakest pace in almost three decades as consumers eased the pedal on major purchases such as cars. The unresolved US-China trade war has deepened concerns about Chinese growth.

Against this, the Chinese Government has pledged to support the economy and is expected to unveil tax cuts and relax bank cash reserve requirements.

Nonetheless, the International Monetary Fund (IMF) expects the US economy to soften in the next two years as the effects of the Trump tax cuts fade, recent Federal Reserve rate hikes bear down on activity and the trade war with China rumbles on.

These developments are buffeting other economies. In Europe, the IMF expects Germany to be hit particularly hard. The euro zone’s largest economy is heavily reliant on exports to the US and China, and the Fund has sharply downgraded its growth prospects, forecasting it will expand by just 1.7 per cent this year.

Slowing European growth

Add to this mix the Brexit fiasco, and the IMF thinks the euro area as whole will struggle to grow by just 1.9 per cent in 2019 – and that is assuming Britain and the EU reach agreement on an orderly exit.

While these issues have been on the Reserve Bank board’s radar for some time, Oliver says the way they have evolved in the last few weeks will have it worried.

“I think they would be feeling more nervous about things than they were in December when they last met,” he says. “We have seen another round of volatility in markets, and a lot of the issues around that haven’t been resolved. Locally, the housing downturn has worsened, [and there are] more concerns about tight credit conditions.”

Despite this, Oliver does not expect the central bank to be in a rush to cut the cash rate and will instead want to see spending measures in the April Federal Budget and the promises made by both the major parties in the lead-up to the federal election before moving.

Amidst such uncertainty, the RBA and its counterparts around the world appear poised to act meeting to meeting, examining data in forensic detail for the faintest hints of how key aspects of the economy are faring.

As Felsman says, “Every policy meeting is now live.”

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September 7, 2018 · 4:13 am

Outlook for property prices: lower for longer?

By Adrian Rollins (this story was first posted by intheblack.com on 7 August 2018, at: https://www.intheblack.com/articles/2018/08/07/outlook-property-prices)

What is the outlook for Australian property prices now that the property market has passed its peak? Will house prices continue to deflate in key markets?

For a country used to ever-rising property prices – they have soared more than 370 per cent in the past 30 years – a new reality of shrinking property values and is taking shape.

Since the market peaked in September 2017, the home value index compiled by property market analyst CoreLogic has slid 1.3 per cent, including a 0.2 per cent decline in June 2018.

The searingly hot Sydney market has been hardest hit. House prices there have tumbled 4.6 per cent since the peak.

Nevertheless, so far the damage to balance sheets has been limited. Nationally, longer-term homeowners have held on to virtually all of their capital gains – prices are still 32.4 per cent higher than they were five years ago.

The property market is deflating, but with a gentle hiss rather than a cacophonous bang.

Nervous mortgage holders and aspiring homebuyers nonetheless wonder how long this decline will last, and how ugly it might get.

Applying the brakes to property prices

Part of the answer lies in understanding what pushed prices so high in the first place, and why they have since turned down.

CoreLogic research director Tim Lawless says easy credit and eager investors underpinned much of the increase in recent years. Buoyed by low interest rates and strong capital gains, investors piled into the property market.

By early 2015, the value of mortgages taken out by investors outstripped those to owner-occupiers, many of them riskier interest-only loans.

At one point, almost half of all loans being written were interest-only.

However, the downturn in house prices has not been driven by higher interest rates or borrowers getting into financial distress. Instead, it has been engineered by regulators, says property analyst Pete Wargent of WargentAdvisory.

Worried by the surge in investor borrowing, financial regulator the Australian Prudential Regulation Authority (APRA) in 2014 placed a 10 per cent speed limit on the growth of loans to investors. Three years later the regulator clamped down on interest-only lending, which had been growing rapidly, imposing a 30 per cent cap on the proportion of new mortgages that could be interest-only.

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Taken together these measures, says Wargent, were “pretty unique” – and effective.

Within a few months of the investor loan cap, borrowing slumped, dropping by almost a third through 2015, and it has continued to decline.

By April this year investors accounted for just 42 per cent of home loans, the lowest proportion since 2012, and growth in investor lending had dropped below 5 per cent, down from a high above 10 per cent.

Interest-only borrowing, too, has wilted. It accounted for more than 40 per cent of loans approved in 2015; by early this year the ratio was less than 20 per cent.

The regulation-driven credit squeeze has dampened housing markets. Auction clearance rates have slumped to less than 57 per cent nationwide, and are the lowest they have been since 2012, according to CoreLogic figures.

APRA released the brakes on investor lending in April but has no intention of relaxing the pressure on lenders, demanding they limit new lending at very high debt-to-income levels, and set debt-to-income levels for borrowers.

Australia: headed for a property crash?

However, the risks already built up in the system are not going away in a hurry.

The Organisation for Economic Cooperation and Development (OECD) has flagged household indebtedness as the economy’s biggest risk. The ratio of total household debt to income has jumped almost 30 percentage points in the past five years to reach 189 per cent in December 2018, and mortgage debt alone was 139 per cent of income.

Although wealth has grown even faster, some who have borrowed heavily may be vulnerable.

University of New South Wales Business School Professor of Economics Richard Holden puts the chances of a house price crash at 30 per cent, most probably triggered by widespread defaults on interest-only loans.

Although Holden says it is most likely that the property market will avoid a collapse, the risks created by more than A$100 billion of interest-only loans are “non-trivial” and cannot be ignored.

The Reserve Bank of Australia (RBA) estimates that each year until 2021, about A$120 billion of such mortgages will convert to traditional principal and interest loans, forcing up repayments by between 30 and 40 per cent.

The RBA thinks most households have enough of a financial buffer to absorb the increase. However, Holden warns that if even just 10 per cent struggle to make their repayments and are forced to sell, that could be sufficient to trigger a crash.

“I’m not really worried about what happens in Point Piper, Double Bay or Toorak,” he says. “I’m worried about what could happen in the western suburbs of Sydney and Melbourne. If there are big forced sales there, then great damage is going to happen to people who can afford it least.”

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Interest rates: the price of money

A sudden jump in interest rates is another risk.

Few expect the official cash rate to budge from its current record low of 1.5 per cent before late 2019 at the earliest.

However, this doesn’t mean borrowers won’t feel some financial pinch.

Wholesale funding costs on international markets are increasing, and already some smaller lenders are responding by pushing up interest rates on selected mortgages.

Lenders including Macquarie, the Bank of Queensland and Auswide Bank have increased rates on variable interest mortgages by an average of between 0.08 per cent and 0.27 per cent, and Lawless expects larger banks will eventually have to follow suit.

Still some life left in the market

Even if the country avoids a default-induced property crash, economists expect that tighter credit standards and the chilling effect of the banking Royal Commission on lenders will force house prices down for some time yet.

Fifteen economists polled by comparison website Finder.com.au tipped that prices in Sydney and Brisbane could drop by as much as 6 per cent by the end of the year, 4 per cent in Melbourne and Hobart, and 2 per cent in Perth, Adelaide and Darwin.

ANZ Banking Group is even more bearish. It predicts prices nationally could fall by 6 per cent from September 2017’s peak to a trough in 2019, including a plunge of up to 10 per cent in Sydney – a view shared by Macquarie Securities. AMP Capital warns they could drop by as much as 15 per cent by 2020.

However, Australia’s status as a destination of choice for migrants may limit the extent of any decline.

The country, particularly its biggest cities Sydney and Melbourne, has been a magnet for immigrants and Australia’s population is growing close to the fastest among developed countries.

Professor Holden says it is on track to expand by 1.6 per cent this year, and all these people have to live somewhere.

With the supply of dwellings set to tighten – building and home loan approvals nationally have both dipped recently – pressure on home prices could again build.

Australia’s seemingly tireless property market might have more life in it yet.

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