In 2014, for the first time since 2004 the RBA did not change interest rates in a calendar year. The slowing growth in the broader economy, and specifically in the housing sector, suggests that this year the RBA will not sit on its hands, and that its first move will be to cut rates.
The last time the RBA changed the cash rate was back in August 2013, and the 17 month stretch without a change in interest rates is the second longest. If the rates are kept unchanged next month, it will tie with the 18 months from January 1995 to June 1996, when the RBA sat on its hands.
But to give you an idea of how different things are now, back then the cash rate for 19 months remained at 7.5% – a rate that seems impossibly high.
Of course the economy has changed somewhat since then.
In 1994, interest rates at 17% were fresh in people’s minds and inflation remained a major concern. The RBA actually increased the cash rate in December 1994 to 7.5% because of fears of inflation due to the economy growing too fast.
Throughout 1994 the average standard variable home loan rate of 8.75% was the lowest for 20 years, and it helped lead to the economy growing 5% in that year. Then, prime minister, Paul Keating, suggested the rates were increased “to shave the top off demand so we keep this recovery sustainable”.
By contrast, the current average variable rate has been at 5.95% for over 12 months. The last time mortgage rates were that low for that long The Beatles had yet to release Let it Be. But rather than needing to “shave” demand, the RBA will cut rates to boost it.
The big change in the outlook came with the September GDP figures in early December, which saw the economy grow well below expectations at just 2.7%.
Prior to these figures, the market suspected interest rates would continue to stay steady for most of this year, with a 50% chance the RBA would cut them by July.
The week after the GDP figures came out, the likelihood of a rate cut by July rose to 74%:
By the start of last week, the market was pricing in a 70% chance of a rate cut by April, and predicting that it would definitely happen by June. This week the expectations of rate cuts have increased even further, with the market suggesting an 83% chance of the RBA cutting rates all the way to 2.0% by the end of the year.
Now, we shouldn’t assume that just because financial traders believe the RBA will cut rates that it will happen. After all, 12 months ago the market expected that the cash rate by the middle of this year would 3.0%.
But there does appear to be a fair bit of evidence that the expectation of a cut is more likely to be right than wrong.
Above all else the main impact of interest rates is on the housing market. Lower interest rates means more people take out loans to buy and build houses and apartments, which means people get employed to build them, who then have money to spend in the shops and thus the growth multiplies throughout the economy.
But despite having such low interest rates, last week the monthly building approvals figures showed that for the first time since May 2012, the annual growth of private sector building approvals was negative:
And it is a trend that occurs across the nation. Most states – even those where the annual growth of building approvals remains positive – have lower growth than 12 months ago. Only Tasmania, coming off a very low base, is experiencing improvement:
Mostly the fall is in the building of apartments, but the growth in approvals of new houses is also dropping.
A year ago the approvals of houses in New South Wales were growing by 26%; now it is just 8% – the lowest since November 2012:
This drop-off was also reflected in the housing finance data released last week.
The total value of owner-occupier housing finance grew by just 0.06% in the past year – down from 18% in December 2013.
And while the annual growth of finance for the construction of new dwellings remains positive at 11%, it is still well down on the 20% this time last year.
And even the growth of investor financing, which is believed to have driven much of the increase in housing prices in Sydney in the past 18 months, has dropped off considerably.
In December 2013, investor financing for dwellings was growing by 34% a year – now it is half that at 17%:
It all suggests a lot of heat is coming out of the housing market quite quickly. While this should reduce the growth of prices and will be welcomed by those trying to get on the housing ladder, the RBA – and the government – will be worried if housing construction continues to slow.
While the RBA is always mindful of employment, its main remit is to watch inflation. But inflation at the moment is hardly a worry at all. With oil prices halving in the past six months, and wages growth at record lows, the problem isn’t that the there is too much heat in the economy, but that it is too cold.
And when the economy finds itself in times of trouble, the RBA governor comes speaking words of wisdom. Whether lower rates will be the answer we’ll have to wait to see, but I can’t imagine Glenn Stevens will be content to let them be.
