In this update we talk about how much impact future cash rate cuts could have, how much borrowers might benefit from them, the big global macro forces driving that could drive us downward, and what it all might mean for the economy and property market.
The RBA hasn’t put the knife away, yet
Back in May I argued the case that the RBA was about to start cutting rates, and cutting they did, with two quarter percent cuts in back to back months in June and July, now I argue they are not done yet, but will be very soon because there is a limit to how effect cuts can be to achieve their targets.
The cuts are to achieve the targets that are all part of the numbers game that the RBA must play.
They are trying to achieve arbitrary figures and results across the economy like jobs growth, wage growth and of course inflation, which we and many other developed economies will likely not experience for a few years yet.
The issue for borrowers and the economy with the coming cut or two is that the banks will not pass on the full amount and it will not spur on spending that leads to inflation.
If you recall an update back in March we talked about how the RBA is trying to change your mind, they are trying to make things cheaper (in reality or perceived) by having low interest rates in a hope to get you to spend more, because the more you spend of either credit or cash the more activity there is in the economy, and the more activity the ‘better’ it is in terms of growth prospects.
But making things cheaper or saving people a few hundred dollars a year on mortgage repayments will only get a marginal bit more of activity happening because people are largely tapped out.
People have a lot of debt, a lot of bills to pay and haven’t got a decent pay rise in a few years. So as the cash rate drops it won’t really flow through to the average persons ability to spend more.
So what happens when the cash rate, currently sitting at 1% drops to .75% and even .50%, or to 0%!?
No one knows for sure.
But one thing is for sure, those people that can buy property will., and that the banks will protect their profit margins and not pass on the full 0.25% cuts if and when the cuts happen.
My estimation is that for the next 0.25 bps cash rate cut the banks will pass on less than 0.15 bps.
And that will be enough to get people borrowing more to buy property. We are addicted to it, and with the change in assessment rates it is a little bit easier to now borrow a little bit more, and the rate cuts, property is heading back up for now, but we need to wait and see what happens on the global stage.
The era of negative rates
Research from within the RBA back in March concluded that a “reduction in real interest rates [effected by the RBA] accounts for most of the subsequent boom in dwelling prices” – that is to say, all their interest rate cuts in the past helped to create the property boom we had over 2012 to 2017.
They are saying they know there is a direct link between rate cuts and property prices going up, and that is quite a staggering claim given they are still cutting the cash rate while knowing the consequences of doing so.
Over the past year property has come down quite a bit, around 10% in Sydney, and so the cuts will lead to a recovery in asset prices rather than, or at least before, another boom.
We are already seeing the result of the June and July cuts play out.
In Sydney last week the clearance rate was ~78% which is basically the highest in two years and since the 2017 peak of the most recent boom.
New mortgage applications are the highest in a year or more. Particularly for first home buyers.
Broker market share or a loans originated sits at all-time highs around 60%.
Enticing fixed mortgage rate starting with a 2 are being advertised.
More stock being sold is starting to trickle in (though many are waiting for Spring).
All of these are directionally positive for property price recovery, so much so that it is likely that the combination of the rate cuts, changes in assessment rates and those other points that Sydney property prices will be back to their 2017 highs within a year.
But there are big macro forces at play as well and the government has largely ignored macro-economic factors that could tilt Australia into a recession, or at least kept quiet on any plans to deal with the inevitable downturn when it arrives.
The apparent complacency in our government on this when clear signs of trouble, is well, troubling. Those signs show that the ten year strong US expansion has run its course, the very accurate recession predictor of an inverted yield curve happened, and final the final boost measures implemented by Trump, in the forms of tax cuts and bullying their central bank to cut rates, have largely flowed through and have been exhausted.
On top of that the unconventional quantitative easing programs where governments buy financial assets like bonds, which has been a key driver plunging the world into an unknown era of negative (real) interest rates has also lost its impact and appeal, but there is no clear way to reverse this global trend, which will certainly make its way to Australia. As a result, the Australian central bank and government will likely follow the same course, that is to say towards 0% cash rate and even negative rates.
What could this all mean? Here is a one sentence summary – the big forces indicate a global recession within 12 months, but local forces indicate property prices to spike in recovery before that happens.