Where to for interest rates?- Cameron Kusher

With interest rates sitting at their lowest levels in more than 50 years, inflation sitting in the middle of the RBA’s target range, economic growth below average and the mining boom slowing we look this week at the expected direction of interest rates.

The overnight cash rate, commonly referred to as the official interest rate, currently sits at 2.75%. It has been more than 50 years since official interest rates have been at such low levels and subsequently, the cost of borrowings, particularly for housing, is at some of the lowest levels seen over this time.

The standard variable mortgage rate is currently recorded at 6.2%, much lower than the 20 year average of 7.6%. Outside of a brief period in late 2008/early 2009, the current average standard variable mortgage rate is at its lowest levels since late 2001. Prior to that you would have to go back to 1970 to find another time when mortgage rates were this low.

Readiness to spend on durables and inflation expectations

Over recent years there has been the introduction of discounted variable mortgage rates. In reality, the vast majority of mortgagees receive these mortgage rates on their home loan.

And as you can see, it means that many variable home loans are now available at an interest rate of below 5.5% (5.4% is the average across the big 4 banks).

With mortgage interest rates so low it is no surprise that there has been a ramp-up in housing finance commitments (albeit from historically low levels) throughout 2013 and a subsequent rise in transaction activity.

Expected Increase in Inflation and Average Readiness to Spend on Durables

A further interesting feature of the current market is that the typically less popular three year fixed mortgage rates are available at a particularly low interest rate.

The average three year fixed mortgage rate was recorded at 5.15% at the end of June 2013. A number of lenders are currently offering fixed rate products at less than 5% with further discounts available for paying interest in advance.

As you can see, average three year fixed mortgage rates are at their lowest level at any time detailed on the third chart. Such low fixed mortgage rates have led to a sharp rise in the proportion of owner occupier loans which are on a fixed rate.

The latest housing finance data from the Australian Bureau of Statistics (ABS) is available to May 2013 and as you can see there has been a trend towards more mortgages choosing to lock in their mortgage at these low rates.

In May 2013, 19.1% of new loans written were on a fixed rate. Of course, the vast majority of mortgagees continue to choose variable mortgages which have a higher interest rate, but it is interesting to note the rising prominence of fixed rate mortgages.

Time Series of CPI Inflation Rate

As at the 26 July 2013, the cash rate futures market indicated a 74% expectation that official interest rates would be cut next month with a 26% expectation that there would be no change.

The futures market yield curve indicates that financial markets are pricing in a further two twenty five basis point rate cuts over the coming nine months with the cash rate anticipated to rise slowly thereafter.

Overall, the chart shows that the market expects the cash rate to be at a similar level to its current 2.75% in 18 months time.

Standardized Lagged Inflation Expectations and CPI Inflation Rate

Given this, we would expect that the housing market is broadly likely to continue on its current trajectory of moderate value increases.

In fact, should the two additional cuts to interest rates come to fruition, value growth may start to accelerate.

Lower interest rates and the subsequent lower mortgage rates are undoubtedly providing an impetus for greater housing market activity.

The key challenge will be maintaining this higher level of housing activity as the unemployment rate nudges higher, commodity prices head lower and economic growth slows.

As a result, the markets more closely linked to the resources sector such as Perth and Darwin may record lower levels of value and rental growth whereas those such as Brisbane and Adelaide that have recorded a sustained period of underperformance may start to pick-up as they start to look relatively more affordable, particularly compared to Sydney, Melbourne and Perth where value growth is currently much stronger.


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Cameron Kusher is Corelogic RP Data’s senior research analyst. Cameron has a thorough understanding of the fundamentals such as demographics, trends & economics. Visit

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