There would need to be a serious change in the economy for any chnage up or down to occur. For rates to rise we would either need a collapse in the dollar or a sudden burst of growth caused by rising house prices leading to lower unemployment. For rates to fall we would need a serious drop off in demand for housing credit and a deteriorating economy. Neither of those scenarios likely in the next couple of months.
The cash rate remained at 2.5 per cent in October -- the thirteenth consecutive meeting without a rate move -- and the Reserve Bank of Australia (RBA) has yet again signalled a period of stability. But despite the almost universal agreement among banking economists that rates will rise next year don’t be fooled, the outlook remains as uncertain today as it was at the beginning of this year.
The Australian economy continues to face a number of headwinds -- which if anything have only exacerbated in the past few months -- and it remains unclear whether the non-mining sector is capable of rebounding sufficiently.
At the centre of the debate are two economic shocks. We know they are going to happen -- it’s already begun -- but there remains uncertainty surrounding their size and persistence. I am talking of course about the collapse in mining investment and the decline in the terms-of-trade.
The mining sector finds itself in a precarious position. Iron ore prices have declined by over 40 per cent this year -- with the RBA’s Commodity Price Index down over 18 per cent -- with prices now posing an existential threat to many junior producers.
That may actually be good news for major producers such as BHP Billiton and Rio Tinto -- less competition equals a higher market share -- but lower prices will also convince some resource companies to either delay or cancel investment projects.
The collapse in mining investment -- based on expectations from the ABS’ Capex Survey -- appeared manageable in the June quarter but since then prices and activity have deteriorated more rapidly than the resource sector anticipated. Expect investment intentions to be downgraded for the 2014-15 and 2015-16 financial years.
The terms-of-trade is falling more quickly than most analysts expected and is beginning to flow through to business profits and household incomes. The household sector is already plagued by negative real wages -- which combined with a falling exchange rate -- has cut into their purchasing power.
Australian households are feeling poor and their plight has hardly been helped by a rising unemployment rate. The labour market has been plagued by an unusual amount of volatility in recent months but most complementary indicators suggest that if there has been any improvement it has only been minor.
Softer commodity prices will also leave behind some collateral damage -- particularly for the federal budget. Lower iron ore prices and the associated decline in the terms-of-trade have taken a bite out of nominal GDP growth and that equals a downgrade to tax revenue.
Federal Treasurer Joe Hockey must either accept higher deficits over the forward-estimates or prepare the electorate for a bout of austerity.
With these headwinds in place, why are banking economists so adamant that rates will rise next year? Either they are downplaying the terms-of-trade decline or they have bought into the notion that house prices are the only thing that matters.
House prices matter a great deal to the health of the Australian economy but from a monetary policy perspective they are just another indicator and certainly less important than the unemployment or inflation rates.
The RBA is set to take steps to ensure that property prices don’t hijack monetary policy and not a moment too soon. Higher interest rates would curb property investment but macroprudential policies can achieve the same thing without slowing the broader economy.
Once you remove the threat of an overheated housing market why would you raise rates? Do private sector economists really believe that the RBA wants to increase the dollar and compromise the recovery? Do they think the RBA will try to undermine the residential construction boom?
The Australian economy remains tentatively poised and faces a number of considerable challenges. Interest rates are supporting activity, particularly residential construction, but it remains unclear whether the RBA has done enough to boost the non-mining and export industries.
Based on the available information, the almost universal belief that rates will rise next year appears somewhat fanciful. Sure it could happen but there is so much uncertainty surrounding the mining sector that we could just as easily find ourselves with lower rates this time next year.
The unemployment rate in Australia may not peak until the end of next year or early 2016, forcing the Reserve Bank of Australia to cut the cash rate from the current 2.5 per cent, according to Deutsche Bank.
Deutsche said in a note to investors that relatively subdued growth in gross domestic product and declining gross domestic income (GDI) because of deteriorating terms of trade will hold back improvement in the labour market over the medium term.
"Given our profile for real GDI growth, we see employment growth as soft for some years, with the unemployment rate peaking at 6.75 per cent come end-2015/early-2016 before a slow decline to [below] 6 per cent come the end of 2018," chief economist Adam Boyton writes.
He says this will give the Reserve Bank of Australia scope to ease monetary policy further in 2015, making Deutsche one of a dwindling number of forecasters predicting a further cut.
The numbers speak for themselves: $67 billion in housing finance has been approved over the first eight months of this year in NSW, according to the Australian Bureau of Statistics.
That's an increase of about 26 per cent over the same period last year and represents 36 per cent of all housing finance approved in Australia.
And so far this year, Sydney has generated $17.7 billion in auction sales compared to $11 billion over the same period last year.
The booming property market continues to provide a stamp duty windfall for the government. Total value of housing sales in Sydney this year will exceed $100 billion.
It is neither a coincidence nor a surprise that NSW has been rated Australia's best economy. The once-in-a decade performance by its capital city housing market has contributed to energising the state economy to its nation-leading status.
Over the past year, Sydney has recorded its best house price growth since 2002, clearly outperforming all other capital city markets. House sales volumes remain at record levels as confidence and enthusiasm remain fully restored in the marketplace.
Yep, still good reason to keep rates at record lows, no sign of bubbles forming either.
One of the region's most senior fixed-income experts has underscored the divide between economists and the bond market by reasserting his call that the Reserve Bank of Australia may be forced to cut interest rates, even after the US Federal Reserve tightens.
Goldman Sachs Asset Management's head of fixed income in Asia-Pacific, Philip Moffitt, said that his forecast for further easing from the RBA was only an outlier in the sense that it was at odds with the consensus of economists.
Economists believe the RBA will raise rates in 2015. However, traders are pricing in almost a 40 per cent chance of a cut within 12 months.
The inability to pass the federal budget in full means that fiscal policy is still reasonably loose, but that – in tandem with slight currency depreciation – only has the effect of pushing out GSAM's call for a cut to next year from this year.
With respect to asset prices, which the RBA highlighted as a growing concern, he was untroubled. "The way we'd analyse it is prices are rising but it's not creating a leverage bubble," Mr Moffitt said.
"The idea that rates are low here from a domestic perspective is absolutely true . . . but benchmarked against the rest of the world we still actually have relatively high interest rates." That yield appeal has kept the Australian dollar high and that may well continue.
GSAM has the Fed poised to lift rates from the zero bound in the first half of 2015.
One of the most hawkish forecasters of the economy, Commonwealth Bank, has delayed the timing of its prediction for the Reserve Bank of Australia's first interest rate rise this cycle to August 2015 from February.
CBA's new forecast still has the RBA tightening in advance of the United States Federal Reserve by just one month.
The RBA's acceptance of macroprudential regulation to cool the housing market has also weighed on CBA's forecasts, in that targeting house prices will in effect buy the RBA time, suggesting rates will be on hold at a record low 2.5 per cent for longer.
"We suspect that this shift in thinking towards alternative tools was done reluctantly," said CBA chief economist Michael Blythe. "But it does indicate a greater reluctance to use interest rates than we had thought likely."
Mr Blythe had been one of the earliest economists to call for the RBA to lift the cash rate, and, while almost all economists now believe the next move for the central bank will be up, traders are still pricing in the chance of an interest rate cut by June 2015.
Goldman Sachs Asset Management head of fixed income in Asia-Pacific, Philip Moffitt, has been one of the most high-profile experts advocating further easing.
All 33 experts and economists in Finder's Reserve Bank Survery have tipped the Reserve Bank to keep rates at a record low of 2.5% tomorrow.
However, a lacklustre economy, high unemployment, the Australian dollar, global uncertainty in the Middle East and Europe, house price pressure and inflation on target, makes it likely that rate hikes will begin in 2015.
Melbourne Cup day has traditionally been a day of cash rate movements – with nine changes on this day in the past 20 years.
Of those surveyed by Finder, 91% are expecting rises in 2015. Two expect rises in 2016.
The general expectation is for rates increases to start increasing in August 2015 before coming to an easing cycle two to three years later.
Finder’s money expert Michelle Hutchison said that rate rises won’t last for long when they do occur.
"Our economy is under pressure to perform better, and all 33 experts in the Finder Reserve Bank Survey believe that the cash rate won’t rise for very long before it will start to fall again,” she said.
“The survey found that the cash rate is likely to peak at 4% in 2017 according to the average forecast.”
However, expectations about when the next interest rate cycle will peak varied significantly– certainly a tough ask this early on.
The majority, 60%, expected the next peak to be in 2017, while a further 27% expected 2016 would mark the peak. A further 13% tipped the top of the next rate cycle to be in 2018.
“One expert – David de Ferranti, Market Analyst at Forex Capital Markets – is forecasting the highest peak, with the cash rate to hit 5.5%. One in three (33%) are expecting the cash rate to hit 4.5% to 5%, a further one in three (33%) expect the peak to hit 4% to 4.25% while the remaining 30% are expecting a peak of between 2.75% and 3.75%,” she said.
“It’s also clear that most experts believe the cash rate won’t hit the high levels we’ve seen in the past. And regardless of when the peak will be reached, it’s likely to start falling soon after.”
Almost 50% of the respondents suggested rate drops in 2018.
“This is great news for borrowers or those planning to enter the property market this mortgage season, as they can prepare for around two years of rising interest rates before they will likely come down again,” she said.
"Borrowers need a buffer of at least $300 per month for an average $300,000 loan if the cash rate hits 4%.”
While the majority of experts predict the Reserve Bank of Australia (RBA) will begin to raise interest rates from next year, the senior economist for Domain Group's Australian Property Monitors, Andrew Wilson, is expecting one more cut.
Every expert in the latest Reserve Bank Survey from Finder, including Wilson, predicted rates to remain on hold today. Of these experts, 91% expected rates to start rising in 2015, with two expecting hikes from 2016.
Wilson, however, predicts the next cash rate movement to be down, cutting the current 2.5% to a new record low.
He further expects the peak of the next rate cycle to be 3.5% during 2018, with rates to start falling again from 2019.
“Mixed signals remain although bias now turning to the downside,” Wilson explained.
He said that the Reserve Bank is waiting for the general economic climate to crystalise.
With house prices now falling, inflation low, unemployment, a high dollar, a weaker share market and rising concerns over the global economic outlook, Wilson's believes this may push the RBA to make one more cut.
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