Will interest rates fall again tomorrow? | Pete Wargent

Tomorrow (Tuesday) the Reserve Bank of Australia will host its March Board Meeting, with the outcome of this meeting hanging in the balance.

At the close on Friday, futures markets priced a cut as more likely than not at a 62 percent likelihood, with another cut to a cash rate of 2 percent by May considered all but certain.

Implied yields on November 2015 cash rate futures contracts are now plumbing new depths at just 1.69 percent, reflective of two further cuts being fully priced in for this calendar year.

cash rate futures

Viewpoints are split on this month’s decision.

Via the medium of Twitter, I enquired of Shane Oliver of AMP if he was sticking with a cut forecast, and given that his response was only three letters long he seemed fairly unequivocal!

shane oliver

Bill Evans of Westpac has also taken the view that if further rate cuts are indeed deemed necessary then they should be cut now rather than later, perhaps seeing this as the so-termed “path of least regret”.

Evans would prefer to see an immediate cut with an explicit easing bias, regardless of whether that bias was later acted upon.

On the other hand, Terry McCrann took to video on Friday in order to predict rates staying on hold, which at least should keep debate centred upon monetary policy this month rather than the overuse of punctuation.

Risks to each decision

The factors I looked at in turn here suggest that the economy, labour market, investment outlook and inflation all appear to be weak enough to warrant a cut, but the RBA has itself identified a risk that lower rates could ignite a rocket under Sydney’s buoyant housing market.

However, given that markets are torn between rates staying on hold or being cut, a decision to stay on hold presumably also risks sending the dollar back up and away from the assumed ~75 cents that the Board would likely prefer to see.

Interest rate history

While interest rate movements and expectations are far from being the sole driver of our property markets, the impacts are likely to be felt more keenly than they were prior to the deregulation of financial markets.

Over the past quarter of a century we have now seen the commencement of five easing cycles, and in every case dwelling prices have subsequently responded by rising within the following 24 months, although as one would expect there can be a lag.

interest rate history

What we can conclude from the above is that interest rate cuts are rarely “lone wolves” and that they tend to come in a salvo.

Discount rates and fair values

It is of course possible to model a fair value for housing markets in order to weigh up a rent versus buy decision through discounting future cash flows and using real mortgage rates as the discount rate.house price sale

However, upon so doing you will quickly discover how sensitive the outcome is to assumptions relating to real rental growth and expected capital appreciation.It has always been my contention that while real rental growth is likely in certain supply-constrained capital city areas due to growing demand and inelastic supply (e.g. inner ring Sydney), it is unrealistic to expect this to occur in most regional or more elastic markets over the longer term.

Assuming real rental growth in a fair value model increases the present value of future cash flows from the implied user cost or rental payments, and also these same forces are what give rise to expected future capital appreciation, although to some extent this is offset by the discounting applied to the final capital gains upon sale.

These two key inputs are inter-related, and generally suggest that home ownership is more attractive than renting where real rental growth is expected, though only for longer term owners due to the high transaction cost associated with Australia housing.

Real estate cycles

Capital city markets will always cycle as construction and therefore supply ebbs and flows in response to demand.

property cycle

But, as I looked at in more detail here, when it comes to property market psychology, expectations of dwelling price movements play at least as important a role in the near term and therefore accentuate the cycles.

This, in short, is why another rate cut will likely send Sydney’s property market soaring – with 2015 forecasts ranging from 7 to 12 percent capital growth and risks to the upside – simply because recent history suggests to a critical mass of those operating at the margin to believe that prices will rise.

CoreLogic‘s auction clearance rates from Melbourne and Canberra on Saturday suggest that it is not only folk in Sydney who presently feel this way.

I should add that from the sheer volumes of people I saw at viewings on Saturday, the inner ring Brisbane market appears very likely to heat up too.

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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


'Will interest rates fall again tomorrow? | Pete Wargent' have 2 comments

  1. March 2, 2015 @ 1:44 pm Craig Turnbull

    Peter, thanks for an interesting article. We have Messrs Oliver and Evans suggesting a cut and while you gave some indications of what you were thinking, I must have missed your opinion? For the record I think the reserve will cut again and then perhaps adopt a wait and see. Though the challenge with that as you point out that it could take some time to filter through to the property market. The Reserve will be watching inflation and the level of the dollar – they do want it around 75c. If it keeps rising, it will bring more calls for lower interest rates

    Reply

    • Pete Wargent

      March 2, 2015 @ 1:58 pm Pete Wargent

      Hi Craig,

      Looking at today’s GDP partials & and soft inflation gauge reading, markets predict it is marginally more likely to be a cut. Either way it’s doubtful that we have seen the end of the easing cycle yet, so it will either be a cut or on hold w/ introduction of an explicit easing bias. Cheers, Pete

      Reply


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