Official interest rates are sitting just 25 basis points above their historic lows. With the local economy patchy, commodity prices falling and the global economy weak how much further will interest rates fall?
Following their monthly board meeting earlier this week the Reserve Bank decided to make no change to official interest rates, keeping them at 3.25%. Although there was no reduction to interest rates this month, many commentators believe that there will be further cuts over the coming months. Official interest rates are currently sitting at just 25 basis points above their historic low (the cash rate fell to 3.0% between April to September 2009) which poses the question, how low will interest rates go?
Official interest rates have been heading lower since they were cut by 25 basis points on Melbourne Cup Day last year. Since the RBA commenced their cycle of rate cuts last year, the cash rate has fallen by 125 basis points to 3.25%.
There are many drivers as to why interest rates have been reduced so significantly over the past 12 months. In the main it is due to the fact that economic data has been generally more negative than positive, property values have been declining over most of the past two years and consumers have continued to save at high levels and largely shun additional debt. As credit demand and consumer spending dried up, the annual rate of inflation fell from 3.4% to reach a low of 1.2%, the lowest CPI reading since 1999), providing the RBA with plenty of scope to cut rates. The high Australian dollar and growth outlook for Australia’s major trading partners was also a key factor in the rate cuts. As a result, the RBA has cut official interest rates in the hope of reviving consumer’s propensity to spend and to increase their levels of confidence.
To-date, the lower interest rates haven’t triggered a wave of consumer optimism with the Westpac-Melbourne Institute Consumer Sentiment Index showing that consumers have been more pessimistic than optimistic over each of the past eight months. Although the data hasn’t shown a noticeable improvement in consumer sentiment, other recent data shows that consumers are perhaps becoming a little more prepared to spend. Retail trade has been trending higher over recent months, as have dwelling approvals and housing finance commitments. Over the three months to October 2012, capital city home values have increased by 0.5% and although home values have fallen by -1.2% over the past year, this is a significant improvement on the -4.4% annual fall over the 12 months to October 2011.
Although interest rates are at such low levels, the rates mortgagees are paying are significantly higher than the official cash rate. The current standard variable mortgage rate is 6.65%, the discount variable mortgage rate is 5.9% and the three year fixed mortgage rate is 5.55%. Although the cash rate is almost at record low levels the standard variable mortgage rate is 90 basis points higher than its recent low of 5.75%.
So where does the RBA go from here? There are plenty of other examples from around the world that indicate that lowering interest rates doesn’t guarantee an improvement in overall economic conditions. In fact, in a recent speech the RBA’s Deputy Governor Phillip Lowe noted that, ‘The very low interest rates in many other economies should not be seen as a good thing or something to aspire to. They reflect those countries’ difficult economic circumstances, and particularly the low risk-adjusted returns available on new investment.’ As you can see by the table, lower interest rates are not necessarily resulting in stronger economic growth. In fact, Australia has higher interest rates and higher annual GDP growth than nine of the countries. Of those with stronger GDP growth, each has higher official interest rates than those in Australia.
Given the RBA’s belief that Australia shouldn’t aspire to very low interest rates we would expect that, although there may be scope for a further interest rate cut, the RBA will want to see plenty of evidence that such a cut is necessary. In our belief, this is one of the main reasons why there was no adjustment made to the cash rate this month.
For some guidance on where financial markets are predicting the cash rate is heading, the ASX 30 Day Interbank Cash Rate Futures index is showing only a 56% chance that the RBA will cut rates on the first Tuesday of December, however, the futures markets sees the cash rate 25 basis points lower by February next year and fifty basis points lower by June.
Subscribe & don’t miss a single episode of Michael Yardney’s podcast
Hear Michael & a select panel of guest experts discuss property investment, success & money related topics. Subscribe now, whether you're on an Apple or Android handset.
Need help listening to Michael Yardney’s podcast from your phone or tablet?
We have created easy to follow instructions for you whether you're on iPhone / iPad or an Android device.
Prefer to subscribe via email?
Join Michael Yardney's inner circle of daily subscribers and get into the head of Australia's best property investment advisor and a wide team of leading property researchers and commentators.