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Could Australia’s short-term rates hit Zero?


Could Australia’s short-term rates hit Zero?

A growing band of commentators are pondering whether Australian rates might fall further. Importantly, for investors, rate cuts from already ultra-low levels should have a positive effect on asset prices – particularly property – but the effect could be more muted, even with strong debt serviceability, given already record levels of household debt. Begging the question of whether the RBA has something else in its arsenal.  Under most scenarios it does appear as though housing will be a low return asset class for some time.

Meanwhile however, stocks happily bounce in sympathy with overseas markets, which imply trend rates of economic growth continuing.

Housing transactions slowing

Starting with house prices, a recent Australian Financial Review article noted a significant slowing in housing transaction activity. This has long been part of our investment thesis, that once house price falls become entrenched, fewer vendors will sell unless forced to. Initially, transaction activity slows as buyers retreat and existing listings take longer to sell.  Eventually the listings clear, either through sales or by unsold properties being delisted as vendors withdraw their property from the market. If this occurs while prices are still falling, fewer new listings replace those that have been removed or sold. Consequently, the number of listings declines.

Recent evidence that our thesis is playing out was provided by one of our brokers Morgans who noted, “New residential listings…appear to be at an all-time low for both Sydney (-20.9 per cent for the 28 days ended March 17, compared to the prior corresponding period) and Melbourne (-15.5 per cent). Based on the data we have been able to access, annual housing churn rates appear to be 2.7 per cent in NSW and 2.6 per cent for Victoria – lower than the depths plumbed in the GFC and the two preceding recessions.”

In terms of listings (NOT property prices), it really IS that bad.

A possible wave of forced sellers…but cannot see it on the horizon yet.

The only possible offsetting influence would be a wave of forced sellers listing their properties.  APRA however has removed the requirement that banks limit interest-only loans to 30 per cent of all mortgages written, which means the previously-feared wave of borrowers being forced from Interest-Only onto Principal & Interest mortgages is no longer an issue.

Given macro prudential measures are no longer a trigger for a wave of forced selling, the remaining possible trigger for a wave of forced selling could be highly-leveraged borrowers either losing their jobs or earning less, for example as a consequence of the sharp drop in residential construction that will soon follow the recent substantial decline in residential building approvals (discussed here.) Importantly, these influences won’t be felt – if they are at all – until later this calendar year or in 2020.  We will simply have to wait and see if that eventuates.  For that reason it would be irresponsible to call a property price crash from here.

Another possible selling wave could come from disappointed property investors – those with untenanted properties or insufficient rental income to maintain mortgages but again that’s just guessing.  Behavioural economics currently doesn’t lend itself to accurate predictions.

Keep in mind APRA’s current imposts on banks, to lend less than six times income, and only to those that can service a mortgage at rate of 7.25 per cent, are doing a good job of ensuring few qualify for a mortgage and thereby stifling demand for property loans, which should be unsurprising given the previous boom suckered in all the ‘low-hanging fruit’.  But again, of itself, that doesn’t present a case for substantial further declines in property.

A Labor victory at the Federal election – who are still campaigning for the removal of negative gearing tax deductions on investment properties other than newly constructed properties – could be a further negative interim influence on prices (It would however be a shot in the arm for the residential construction industry).

Unsurprisingly, it has been reported that the Reserve Bank of Australia (RBA) has asked APRA to lower is ‘serviceability calculation.’

RBA and federal Government to the rescue

If APRA digs its heels in, rendering the RBA unsuccessful in pushing for the ‘stressed borrowing rate’ to be lowered, the RBA could conceivably reduce the serviceability calculation by cutting its cash rate from the current all-time low of 1.5 per cent.

Amid continued house prices declines the RBA may be compelled to act. RBA Governor, Philip Lowe recently noted “it is important that banks are prepared to take credit risk… if they can’t do this, then the economy will suffer.”  He’s right.  Falling house prices and negative equity has the potential to be destabilising.

Given the savings rate is likely to rise amid plunging house prices, and the RBA noted that “credit conditions tightened more than was probably required” one should reasonably expect the central bank to cut rates. Remember the RBA has already cumulatively lowered its economic growth forecast by 125 basis points to 2.75 per cent.

Lowered demand for property is not helping property prices or the construction sector.  Meanwhile, the stalled consumer is hitting retail franchises.  This could lead to weaker employment levels and pressure on wages.  Without the RBA acting, these factors would be negative for house prices.  But the RBA can act.  The Australian government also has a budget surplus and relatively low levels of debt, which gives it ammunition to think about stimulus measures.

With respect to the RBA’s predicament, one view now receiving some air time is the possibility that the Australian overnight cash rate is cut to zero.

Some are suggesting that given; 1) it is unlikely the banks will pass the full savings on to borrowers (not withstanding their funding costs are declining), and 2) the utility of further rate cuts declines as rates approach zero, it may be that the RBA engages in less conventional policy measures.

Indeed, back when he was assistant governor, Philip Lowe pointed out that unconventional measures could be considered once rates fall to around one per cent.

But an easing of lending standards for example is highly unlikely given the recent Royal Commission and especially since APRA noted that “changes we have made to lift lending standards are …permanent” and ASIC confirmed that the HEM approach to assessing mortgage serviceability “does not provide any positive confirmation of …consumer’s income & expenses.”

It’s simply too hard to know what measures will be taken simply because the mere mention of them today could significantly reduce confidence in the economy. Instead, at this stage it is more probable that rates are cut more aggressively and/or that they fall well below one per cent.  Either way we are probably beyond the point where a soft touch will do the job.

For property investors we posit the following; in the absence of a global and or domestic recession, property prices have a little left to fall because home owners may be rescued by intervention.  If a recession transpires however all bets are off and property prices fall much further.  I’d estimate the probability of a recession at circa 20 per cent.  For clarity, that means 80 per cent chance of no recession.


Roger is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Gee Roger, I like that line”behavioural economics currently does not lend itself to accurate predictions “ in other words a polite way of saying it’s all BS – as I’ve been saying for years.
    The RBA owns this entire (bubble) problem due to the above and it’s therefore ill-informed decisions over the last few years that have lead to it.
    So its obviously cheap and easy money that led to the current predicament, and yet they now want to make it cheaper and easier as they have been doing for decades now, but they have fixed nothing in doing so and made things far worse, and doing the same now will give the same results as before, bigger bubbles bigger problems, and what’s worse is that they want pensioners and savers to pay the cost, it’s criminal, it’s stupid as seen before and before and before that.
    We badly need a recession, we needed it years ago, but now when it hits it will be bigger than Ben Her, because of all the bad non performing investments we have stuffed into the system with cheap money, the entire property casino is a perfect example of this, but it’s only one. I just fail to understand how the RBA etc can’t see this simple fact.
    Yield was destroyed years ago with cheap money, now capital gains have disappeared from the property market. Can you think of any other reason an investor would invest in property ?
    I can’t , it will fall further.

  2. In all the discussions and commentary on very low interest rates there never seems to be much regard given to the negative effect it has on retirees’ savings, income and spending behaviour. With over 3.5 million retirees in Australia, I would have thought any change to their spending behaviour would have some effect on the wider economy?

    • We have written here at the blog about the adverse impact on savings and earnings for retirees. Low interest rates reduces savings which is, unfortunately, what the economy needs when it is slowing down. Save less and spend more! However retirees, who are entirely dependent on their savings for spending, are caught in the cross fire.

      • And that is the problem, pensioners and savers should not be made to pay for the stupid and failing pursuits of the RBA and the criminal banks and the even stupider property investors. These bad investments should be flushed out of the system, and not be forever supported by savers. Besides being unsustainable in the long term, it’s morally abhorrent, and the very fact that the RBA has allowed itself to be painted into a corner, clearly shows its total incompetence and why it should be abolished.

    • Always a good point in my opinion, but that whole retiree savings chestnut seems to be a thing of the past. Twenty years ago retirees were well represented by lobby groups who had a voice every time the RBA cut rates. Where are they now? Dead silent. The problem is an extraordinary number of retirees jumped into the property bubble and are so dependent on the continued speculative capital gain. Ask yourself how many retirees these days still have a mortgage compared to twenty years ago or how many have a property within an SMSF? They don’t seem to sit in low risk asset classes any more and there’s an entire financial planning system biased towards selling them riskier products where the clip for the advisor is higher and more importantly is ultra reliant on ever decreasing interest rates.

      • andrew ronan

        That’s true, the entire system relies on increasing asset prices, it’s all about capital gain, yield is a now an ancient relic of the past, but we are nearing the limitations of asset price growth as can be seen in the property bubble now, there’s no reward for risk anymore, you’ve got to wonder where we go from here.

  3. I note that labor, in addition to proposed changes to negative gearing, capital gains tax and franking credits, is this week talking about increasing the minimum wage. I can see the benefit of all these changes, but we are late in the cycle, house prices are falling, the economy is not growing, consumer confidence is down, we have record high household debt, credit is tight, China and the EU have got the wobbles, the US yield curve has begun to invert…… is the timing right?

  4. matthew russo

    Interest rates are already at record lows in Australia and remain at record lows elsewhere around the world and yet it appears to have done little to kick start the global economy in a post GFC world. Despite this the Australia economy appears to be struggling and many believe the US is headed for recession.

    Does anybody believe that simply cutting interest rates further in Australia will solve the variety of complex and structural issues we are facing?

  5. There are a lot of moving parts relevant to this analysis. 20% may well be right but my feeling is there a feedback loops at work that make these predictions very difficult. What I would say is that things seems to be steadily worsening in multiple areas and it may be that government intervention on one of these loops does not solve problems that have already occurred in other ones. For example the decrease in jobs available for builders and a change in their psychology – especially if building sites are being left half built – is hardly going to respond to lower interest rates or first home buyer grants. That said it always easy to be a pessimist.

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