Cautious welcome for RBA interest rate cuts
Low is the new normal for interest rates as Australia follows a global trend
Australia’s official interest rate cut to a record low this week has sparked a debate in the country that will be very familiar to global market-watchers: whether a short-term policy boost to labour and housing markets is setting up unnecessary risks down the road.
The Reserve Bank of Australia dropped its benchmark interest rate on Tuesday by 25 basis points to 0.75 percent, citing downside risks to the global economy. It was the bank’s third cut since June, firmly entrenching the lower-for-longer approach that has become the norm for the world’s major central banks.
In Australia, like elsewhere, the short-term effects of the cut have been broadly welcomed. With more homeowners living with mortgages than retirees living off savings, the effect on the economy is still likely to be positive overall – though it is likely to be blunted by major banks not fully passing on the cut to mortgage rates.
For real estate investment markets, offshore investors are expected to show continued interest in Australian real estate due to a wider than average spread between property yields and the real risk-free rate.
The cash rate reduction has exerted downward pressure on the Australian Dollar, making the entry point cheaper for USD-denominated funds.
However, the long-term effects have some economists feeling uncomfortable.
“There’s no doubt this is could lead to another round of yield compression and higher asset prices,” says Andrew Ballantyne, Head of Research, Australia, JLL.
“We’ve heard the phrase ‘lower for longer’ for years now, but ‘lower for longer forever’ is the new term. While nothing lasts forever, we are in an unprecedented cycle and asset values would be sensitive to any upward movement in interest over the next five or more years.”
Australia’s economy grew by 1.4 percent in the year to June, the lowest recorded annual rate since 2009. RBA governor Philip Lowe said it was “weaker than expected”.
In cutting the official interest rate, the RBA hopes businesses will have the confidence to invest in larger workforces and therefore drive down unemployment and increase wage growth, both of which appear to have stalled in 2019. The bank also aims to reduce the risk of the Australian Dollar rising to uncompetitive levels.
For real estate investors, the cost of borrowing has never been cheaper. The BBB corporate bond yield, which can be a proxy for the cost of debt, is now 2.09 percent, down from 3.78 percent at the start of the year, following a downward trend for the past 10 months.
Still, a softer labour market and reduced leasing activity could impact real estate rental growth, says Ballantyne.
“Occupancy rates remain elevated across most office, industrial and retail categories,” he says. “However, a softer economy implies a moderation in employment growth, negatively impacting on occupier demand.”
Housing in the balance
In the housing market, the RBA has faced a delicate juggling act between boosting sales activity and a policy that creates overheating.
Sydney and Melbourne have seen four straight months of price gains, growing at 1.7 percent on average each month, CoreLogic data show. The strength came on the back of the two previous interest rate cuts, as well as the Coalition government’s election win, and an easing of macro-prudential safeguards.
“This recovery in housing market transactions and prices is a good thing for the broader economy and households’ confidence to spend,” says Leigh Warner, Senior Director, Research, JLL. “The latest cut will further help this process, but we do expect the recovery to slow a little in coming months as more listings in the existing residential market re-emerge and the realities of a softer local and global economic outlook set in.”
As the effect of the latest cut plays out locally, the measures taken by central banks globally to shore up their own economies will have a major influence on the RBA’s next move, with further cuts still a possibility.
“The bottom line is Australia is being dragged into the super-low interest rate environment that much of the developed world has been in for long time,” says Warner. “Interest rates could quite likely still fall further and regardless will stay super low for some time. This is the new normal.”