What’s the prospect of a March interest rate cut to a record low of 2.75%

Speculating what’s going to happen to interest rates is something of an idle national pastime in Australia, especially for those interested in property investment.

But why do we bother trying to pick the direction of interest rates at all?

One answer is that buyers of property indulge in the guesswork in order to determine whether locking in a fixed rate mortgage will see them better off, albeit often fruitlessly.

By Tuesday of this week, relentlessly bullish stock markets and a flow of positive news had seen the futures markets quickly slice the likelihood of another interest rate cut on March 5 from ‘more likely that not’ (55%) to ‘unlikely’ (26%).

A turbulent 24 hours and a global equities sell-off (triggered by a hint that the US Federal Reserve may be shifting its stance regarding the duration of its bond buying program) saw a little uncertainty return with a 31% chance of a cut priced by the close of trade on Thursday.

 

Source: www.asx.com.au

Considerations for the March 5 meeting

We know that the Reserve will consider the same half dozen factors in its March decision that it always does, so here’s where things stand:

Inflationthe RBA is an inflation-targeting institution with its monetary policy targeting a range of 2-3%.

With core CPI tracking at comfortably below the middle of the band (weighted median and trimmed mean both appearing benign and tracking at just 2.3% year-on-year) and the headline CPI also appearing to be little threat, inflation is not a barrier to an interest rate cut.

This is a key point and we know that this is so because the RBA told us that inflation “would afford scope to ease policy further” in its February Minutes.

With growth in Australia exclusive of mining known to be weak, this is a strong argument in favour or further easing and a cut to 2.75%. Inflation seems unlikely to increase materially with ex-mining growth below trend.

Global growththe RBA indicated this week that it feels that China’s growth could stabilise at around 8% per annum, although yesterday we witnessed a wobble related to fears of real estate speculation in that country.

Commodity prices – the commodities index had been tracking very comfortably from November through January, up by more than 5%. By March 5 it looks possible that this sentiment may have reversed somewhat.

The all-important iron ore spot price continued its amazing rebound from just $87/tonne to a new recent high of above $158/tonne, a bounce of more than 80%, before it eased a little overnight. However, the Assistant Governor of the RBA Christopher Kent noted in a speech this week that most observers believe that iron ore prices are unlikely “to be sustained at these high levels”.

The short-term outlook appears a little less rosy for investors in copper producers.


Financial marketsit’s been a heck of a 6 months for equity markets, which may have been one factor obscuring the need for a further rate cut to keep Australia’s growth close to trend.

Yesterday saw the XJO (ASX 200) smashed by 2.33% which was the biggest one day fall in nine months, but this sell-off still represents only one material drop in recent trades. Whether we are yet to see a major correction remains to be seen.

Source: www.asx.com.au

The resilient Aussie dollar has eased by around a cent but the RBA appears uncomfortable with its “persistently high level” in spite of 175bps of cuts delivered, the Aussie buying ~102.5 US cents today.
Financial conditions – the RBA has warned that its previous rate cuts take some time to flow through to the economy and has noted on more than one occasion a consolidation or a strengthening in housing prices.
Despite all the talk of “rapid house price appreciation”, I remain somewhat sceptical. While residential housing market sentiment seems to be picking up in some capital cities, on a nationwide basis I’m yet to be convinced that the reported growth is much more than a mirage or perhaps an uptick in median prices caused by a shift in the sales mix.

Domestic demandOverall, Australia has remained relatively unscathed to date with the mining capital investment boom keeping growth close to trend. But it is well known that we can thank almost exclusively the mining boom – yes, that boom which we are told is about to peak – which has kept growth at around trend to date.

Source: abs.gov.au

A quick glance at what is on the horizon tells us that one of the key pieces of Australia’s economic puzzle will be revealed next Thursday in the form of the ABS capex release, which includes a survey of investment spending intentions.

Mining investment has been an amazing story, and it’s not one which will sink without trace overnight. But the peak of the boom is precisely the point at which the RBA needs other sectors, including that of housing construction, to step up and plug the gap as Australia undertakes its “great rebalancing” to mining production.

One has to conclude that a weak result next Thursday would see the RBA being inclined to cutting its cash rate to record lows of 2.75% sooner rather than later.

Further cuts to come?

The ASX 30 Day Interbank Cash Rate Futures implied yield curve shows that we might well expect another rate cut in 2013 (perhaps two) but timings are always and forever uncertain.

Source: asx.com.au

The yield curve implies that the RBA may adopt a ‘wait and see’ approach for the next two months.

However, if it is suggested by next week’s capex data that the mining investment boom is going to peak imminently, then it’s possible that the RBA will pull the trigger on another rate cut sooner than we think.

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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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