Finance Market Update - 21 June 19
With more cash rate cuts on the horizon we need to consider how much the banks will pass onto customers and new borrowers, and what that means for property prices. We discuss this and more in this fortnights update.
The RBA’s numbers game
The reason the RBA cuts the cash rate is to boost economic activity and see specific economic indicators and numbers, such as seeing inflation in the 2% - 3% band, getting unemployment to around 4.5%-5% and keeping the money flow and economy running.
The most recent inflation number was a dismal 1.8%, well below target (which is being argued should be lowered to more realistic levels), and unemployment is around 5% with ‘under’ employment suggested to be double that.
Because both of these numbers are not where our central bankers would like them to be they are going to pull the main lever they have, the cash rate, again.
But what happens when the cash rate drops, again (and again)?
For mortgage holders and new borrowers this means a lower interest rate on their mortgage, the standard rate cut is 0.25, but it is unlikely that full amount will be passed through to borrowers by the banks.
The last rate cut saw the big banks pass between 0.18 and the full 0.25 onto existing and new borrowers, which I correctly predicted would be the spread.
Given many economists are predicted 2 more cuts this year, the question becomes, how much will bank’s pass on and how much will that help people?
Numbers as low as 0.15 (of 0.25) have been talked about and I would agree with that. It is likely we will only see around 0.15 passed onto mortgage holders in the next and second cut.
If and when that happens, the advertised standard variable rates from the big banks will be an astonishingly low of around 4. something %.
Of course, that is a ridiculously high rate and you should have your mortgage interest rate sitting at around 3.6% (or even lower) depending on LVR and other factors. If your rate isn’t there, think about a refinance to save money.
And for a third rate cut this year?
Don’t expect the banks to pass on more than 0.10 (of 0.25) from that one.
Of 2 cash rate cuts totalling 0.50, if my numbers are correct, customers would only get 0.25 of that, about half.
Even though the full benefit isn’t going to get to us, this is very welcome news as it will lower the total interest expense on mortgages (and business loans) and the monthly repayment amount as well, putting hundreds or thousands of hard earned money back into peoples pockets.
It is worth remembering that the RBA cuts the cash rate when it is worried about not hitting its targets and the economy, so the underlying notion from this is that they are worried about the economy. If these lower rates don’t help them hit the numbers they want to see, you can bet they will start a quantitative easing program and start buying up financial assets like bonds at a rapid rate.
Borrowing activity and power
One of the key flow on effects from cheaper money (and mortgage debt) is that people think it is a good time to borrow to buy property.
I’ve talked about before the psychology of rate cuts and this how that influences, or at least how the RBA tries to influence, spending and borrowing habits, and this recent lift in buying activity after the cash rate cut in June is a prime example.
Already over the past month we have seen auction clearance rates lift from around 50% to around 60% across Australia, open homes get three times as many people and mortgage inquiries significantly uptick.
Confidence is returning, but just because you want to buy a property doesn’t mean you can, or at least, doesn’t mean you can borrow as much as you would like.
Borrowing power is one of the important factors that influences people’s ability to buy property, and overall affects prices of properties because the more people can borrow the more they will spend. If you can only borrow $900k your hand will come down earlier at an auction, and the price might not get as high as it could, if you and the others could all borrow $1.1 million and create a bit of a contest.
During the Royal Commission borrowing power reduced by 10% - 20%. This was largely a knee jerk reaction by the banks worried about “responsible lending” laws and avoiding being on the front page of the newspaper (again) for the wrong reasons.
Now we are seeing the banks perspective change.
Only yesterday the first of the big banks, Westpac, announced they are taking on board APRA’s reduced servicing comments made a few weeks ago, and lowering the ‘interest rate floor’ from 7.25% to 6.5%.
This could see around an 8%-10% jump in borrowing power, and other banks are likely to follow suit.
The question is, will this be enough to change the direction of property prices?
Not right now, and not that change alone, and credit is the reason.
APRA released figures this week that showed a massive 16.4% drop in the dollar value of mortgages written by “ADI’s” (“authorised deposit taking institutions”, which is basically lenders with the word ‘bank’ in their name) in the first 3 months of this year.
That correlates pretty strongly with the fall in property prices and suggests the notion I always bang on about of credit driving property prices has weight.
The 16.4% number means that the overall dollar value of mortgage debt, of money people have to spend on property, is significantly lower.
How can prices for property go up if people don’t have as much money to spend on property?
Well, to see the direction of prices change to up, we will need to see more rate cuts and almost all banks and other lenders lower their assessment limits. It is likely the supply of credit will increase if these things happen, which will give people more money to spend on property, which will, as we know, start to drive prices higher along the road of recovery.
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