Synopsis

28 economists now expect official interest rates to drop by 0.25% to 1.75%, before February 2016.   So, why could this happen (remember, these are the same economists who didn't see the GFC coming and agree with Treasury growth forecasts – which are nearly always wrong).

Comments

You probably wouldn't look at the charts if I included them, or the long-winded explanation of them, but there are several factors that are critical:

- The unemployment rate remains high at 6.2% (the core rate is regarded as 5.4%), trending upwards from 2011 despite the mining boom.   There are 780,000 looking for work.   When unemployment is high, wage growth slows, and core inflation is low.   So, the Reserve reduces interest rates to increase activity and inflation.

- The annual inflation rate is 1.5%, well below the target band between 2% and 3%.

- Monthly new dwelling approvals have been trending down since late 2014 (reducing from 20,000 a month to under 18,000).   The economy is transitioning to a low capital demand one, which is being hampered by falling population growth, low productivity, and a housing construction market which appears to have peaked.

- New housing approvals by type shows the current housing construction wave is in mid to high-rise apartments, which are sold to speculators, investors (esp. SMSF's) and increasingly offshore buyers.   Detached houses in the late 1980's were over 75%, but currently are just 52%.   Only speculation and investment seem to be causing the shift in housing demand and product needs.

- Seller asking prices over the last 12 months are mostly about Sydney (15.7%) and Melbourne (9.1%).   Very little is happening outside those markets – and auction clearance rates in those are down substantially over the last 60 days.

Why will Interest Rates fall?

Glad you asked!   Lower short term rates are likely with conditions of persistent high unemployment, low inflation, falling housing demand and a dollar that is stubbornly high.   This, in turn, indicates that the yield curve (the rate for 10 year bonds minus the rate for 90 day bank bills) is a bellwether indicator to watch for interest rate changes.   Short rates are currently 0.50% lower than long rates, and is considered 'neutral', that is, settings are neither too loose nor too tight.

For quite a while business confidence has been shaky, but that   may be more a reflection of a dud Abbott/Hockey government than volatile consumer demand.   In September, business borrowings had a large lift, which could result in the hiring of extra workers and the purchase of new equipment.

The RBA's neutral stance shows it is watching what business is doing, and if economic conditions don't improve, it could drop interest rates further to lift consumer demand which flows on to improved business activity.

My Guess?

More likely down than up, perhaps 2 x 0.25% reductions in the next year.   The dates depend on the yield curve and to some degree, the election late next year (was that too cynical?)

The material and contents provided in this publication are informative in nature only.  It is not intended to be advice and you should not act specifically on the basis of this information alone.  If expert assistance is required, professional advice should be obtained.