We are changing our near-term interest rate call on when to expect another cash rate cut from the RBA. Previously we forecast that the RBA would cut the cash rate by another 25bps to 1.25% at its November policy meeting shortly after the release of another very low quarterly CPI report in late October. We still expect another very low CPI, but signs that the Australian economy is travelling better for the time being is likely to delay the next rate cut until mid-2017. We have not changed our view that low interest rates will persist for some time, but temporarily interest rates could be a touch higher than we previously thought likely.
As we wrote last week, Q2 GDP confirmed relatively strong annual Australian economic growth in the first half of 2016. Our view remains that economic growth will not be quite as strong over the next year as the contribution to growth from housing activity weakens and the contribution from household consumption spending fades. We also expect erratic contributions to growth quarter-to–quarter from government spending (the major contributor to GDP growth in Q2 2016) and net exports (the major contributor in Q1).
Set against this story of mostly fading contributions to economic growth there are two positives. The biggest part of the negative pull on growth from declining mining investment spending is almost over. Also the big detraction to Australian national income from sharply falling export commodity prices has part reversed in 2016 so far and if prices stabilise from here, the period of falling national income may be over. It is the substantial moderation of these two big negative influences – falling mining investment and falling export commodity prices – on Australia’s growth outlook that was referred to in a speech by RBA Assistant Governor Kent last week titled “After the Boom”. That speech seemed to imply that the RBA is close to reviewing the need for any further interest rate cuts.
Another reason why the RBA may be reviewing the need for further rate cuts is that the long slide in annual wages growth to record-low territory over the past year or two may be starting to stabilise. The RBA is also encouraged that the unemployment rate has stayed lower than it forecast over the past year.
The need for the RBA to cut the cash rate again in the near future could be fired up if Q3 inflation readings were to come in much lower than expected or if there was some sharp deterioration in the economic growth outlook, but the probability of either of these events occurring seems quite low. Instead the fade in Australia’s economic growth rate outlook that we expect and with it grindingly low inflation reports will take time to show through, probably until mid-2017.
In our outlook, we do expect material downward pressure to show in home building activity, especially multi-occupancy dwelling construction, and house prices by Q1 2017. The cause of this weakness, apart from pockets of significant new housing over-supply starting to develop in the two previously strongest markets, Melbourne and Sydney, is tightening access to housing finance and also higher home loan interest rates.
A move by the RBA towards a neutral monetary policy stance occurring at a time when the US Federal Reserve is edging closer to raising its funds rate and the European Central Bank also seems to be moving away from “doing as much as it takes” on monetary policy, to “done as much as we can” is likely to raise government bond yields a little everywhere and perhaps widen the spreads at which non-government paper trades above government bonds too. In short, just by moving to neutral, the RBA could place significant upward pressure on Australian banks’ funding costs that most likely will be passed through in higher lending interest rates, including home loan interest rates.
If the November RBA policy meeting comes and goes without another cash rate cut, as we think now is likely, home loan interest rates could rise within weeks of the decision. As a result, we see noticeably weaker housing market conditions developing early in 2017 which will tend to make worse the fade in growth in household consumption spending. Signs of weaker economic growth and probably weaker labour market conditions too will, in our view, bring the RBA back to easing the cash rate in May or June 2017. The bottom line is that we now see a stable cash rate at 1.50% persisting through to mid-2017, when the cash rate is cut by 25bps to 1.25%.