The Reserve Bank of Australia (RBA) has revealed fears over collapsing commodity prices and the terms of trade, coupled with fears over weak business and government spending, have contributed to it cutting the official cash rate.
Yesterday, the RBA announced it is cutting the official cash rate by 25 basis points to a new record low of just 2.0%.
In a statement, RBA governor Glenn Stevens said declining commodity prices and below-trend growth in the Australian economy were key factors in the decision, mirroring similar concerns when the RBA cut rates in February.
“The global economy is expanding at a moderate pace, but commodity prices have declined over the past year, in some cases sharply. These trends appear largely to reflect increased supply, including from Australia. Australia’s terms of trade are falling nonetheless,” Stevens said.
Along with sluggish business demand caused by the end of the mining boom, the RBA also blames a lack of public spending by governments for the weak state of the Australian economy. A situation Stevens hopes to correct by encouraging the housing market.
“Looking ahead, the key drag on private demand is likely to be weakness in business capital expenditure in both the mining and non-mining sectors over the coming year. Public spending is also scheduled to be subdued,” Stevens said.
“Low interest rates are acting to support borrowing and spending, and credit is recording moderate growth overall, with stronger lending to businesses of late. Growth in lending to the housing market has been steady over recent months,” Stevens said.
The RBA also observes a two-speed housing market is emerging, with strong growth in Sydney property prices, while housing market growth remains weaker interstate.
“Dwelling prices continue to rise strongly in Sydney, though trends have been more varied in a number of other cities. The Bank is working with other regulators to assess and contain risks that may arise from the housing market. In other asset markets, prices for equities and commercial property have been supported by lower long-term interest rates,” Stevens said.
However, at this stage it is still unclear whether business owners will enjoy the full benefits of the rate cut.
Of the big four banks, the rate cut is being passed on in full to consumers by ANZ, while the Commonwealth Bank passing on just a 0.2 percentage point cut, rather than a full 0.25 percentage point cut. As of publication, neither NAB nor ANZ have announced whether they will pass on the rate cut to consumers.
The RBA’s rate move was anticipated by AMP Capital head of Investment Strategy and chief economist Shane Oliver, who told SmartCompany further growth in the Sydney property market could require intervention from Australian Prudential Regulation Authority.
“I think what we’re seeing at the moment is a reversal of what was happening mid-last decade,” Oliver says.
“In the middle of the last decade, Sydney housing market was cooling off. Despite that, the RBA was hiking interest rates because of the mining boom, which was just getting underway at the time.”
“Now it’s moving in the opposite direction – the mining boom is cooling off, meanwhile Sydney housing prices are up 15%, compared to just 1.7% in the rest of the capital cities.”
“NSW was struggling, partly because of the mining boom and partly due to politics. Now it’s going through a renaissance. There are stronger tourist arrivals as the dollar falls, along with a property boom.”
Oliver says lower interest rates combined with low inflation could stimulate business investment, along with housing markets outside Sydney.
“The RBA made the right choice, and it’s time for APRA to step up and regulate the Sydney property market. APRA has said it will take actions any of the banks growing their property books by more than 10%, and now it needs to make a public of any bank that does,” he says.
Oliver also says bank term deposit rates are becoming less and less attractive. He says investors have to get used to ongoing low interest rates and people still relying on bank deposits should consider alternative sources of yield and return.
Ahead of the federal budget, Oliver says infrastructure is the key element of any plan to increase public sector demand.
“As a general principle, Australia needs more nation building infrastructure,” he says.
“The problem many governments face is the state of their budgets. That said, by all rights a state like Western Australia should be privatising assets and taking advantage of the federal government’s asset recycling scheme – and Queensland should be doing the same.”