that’s what always happens in Dec …

The RBA cut their target overnight cash rate 25bps to 3%, as was widely expected prior to the meeting (the market was pricing 23/25bps at Tuesday lunch).

The reasons were domestic this time, with a little more domestic weakness allowing the bank to detune the inflation concerns that held them up in November. The final paragraph did not contain the forward guidance that is typically at the end of an RBA statement — however this is very normal prior to the December break.

The RBA — so far — has been unsuccessful in easing monetary conditions with their December window. The FX and rates markets both over-reacted to the normal lack of forward guidance the December post-meeting statement: the AUD immediately gapped higher, and the bill strip bear-steepened. Interestingly, the OIS market remains priced for a cash rate low of ~2.5% in Q3’13.

Following this cut, It is likely that mortgage rates will fall by ~20bps, to be ~50bps above their GFC lows. It is unlikely, however, that the housing market is going to boom as it did in 2009/10. Without that, i find it hard to see demand growth picking up to be above trend in the non-mining sector — which is what i think is going to be required to offset the weakness i expect in the mining and government sectors.

You could get a sense of this from today’s building approvals data — which showed a 7.6%m/m decline. It was mostly due to the volatile ‘other’ sector, however the ‘core’ private housing estimate also declined by 1.5%m/m, to be only +4.5%y/y. This is very modest growth for the sector that optimists hope will fill the gap left by the fiscal contraction, and decline in mining investment.

Still, we have a cash rate that’s at the all time low, and mortgage rates that are only 50bps or so above the lows — so why am i so pessimistic?

Here are six reasons:

1/ There are no longer extremely generous government incentives to invest in housing.

2/ The restrictions on foreigners purchases of Australian housing have been re-introduced.

3/ The AUD is stable — whereas in 2008 it fell 40% in three months (this was a great support to the luxury housing market, as well as the tradable sector).

4/ Expectations (or animal spirits) for capital gains on housing are much lower.

5/ Lending standards are (modestly) tighter.

6/ The fiscal stance is now modestly restrictive, rather than extremely stimulatory, as was the case in 2009.

These reasons are all apart from the most obvious — that we do not, this time, have an investment boom promised by jaw dropping profitability in a sector. Rather, we have an economy characterised by declining profitability, excess capacity, and weak business confidence.

Given the above, i judge that the probability this is the end of the easing cycle is ~10%.

More likely, the unemployment rate will rise, as GDP slows to be clearly below trend, and that will see inflation test the 2% bottom of the RBA’s range, and allows the bank to cut rates another 100bps over the next year or so.

I don’t normally make GDP forecasts, but a number closer to 0.25%q/q seems more likely to me than the 0.6%q/q the market is looking for when Q3 GDP prints tomorrow (5 December).

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23 Responses to that’s what always happens in Dec …

  1. Rajat says:

    Lack of guidance in December might be typical but the statement was still way too chirpy. MQG put out a good little note saying “the RBA’s commentary is still very much of the ‘glass half full’ variety.” Your comment that a fall in inflation would “allow the bank to cut rates another 100 bp…” captures that sentiment – there is no real intent to stimulate, to reduce real rates – only to allow real rates to stay constant as inflation slows. It’s a dangerous game.

    • Ricardo says:

      It seems that they have talked themselves into being behind the game. Part of it was their RDP where they said they cannot forecast growth but are okay at inflation. seems that now they are going to be reactive on growth and take their inflation forecast too seriously.

  2. On your Marx says:

    oh goody something to disagree with only a bit though.

    no lending standards are not tighter now. That would be impossible.

    no it isn’t modestly restrictive, it is a bit more than that.

  3. ssec says:

    Why would a first home buyer buy a house now when renting is cheaper (and A LOT more flexible, a lot less risky), prices are not going up and rates are going down? Let’s be clear: there’s lots of demand when real estate prices are going up (and prices are going up when there’s lots of demand), but when prices are not going anywhere, demand is much lower, and when demand is much lower, prices are not going anywhere.

    What role do rates play in this? Not very much, on the way down, IMO. When you buy a property for 500K, and the property goes up 5% p.a., you are very confident in your investment. Should I not be able to make my repayments I can always sell easily if the market is good, and even maybe make some nominal money (nominal = most important). But if you feel there’s a chance of values that are going backwards for the next few years and/or you won’t be able to resell your property easily, you will think about it many times before jumping in and take a huge mortgage. And this confidence is much more important than the level of rates. In many countries it was proven that lowering rates is not enough to break this feedback loop.

    In my opinion the proper way to prevent this boom/bust is to avoid excessive rises in property prices, but it’s too late for Australian property. Property is now very expensive, lots of demand has been carried forward and if prices are not clearly on the way up (but how can they from these levels and in this current world economic cycle), confidence is lagging.

      • Ricardo says:

        If we don’t get a weaker AUD we are going to need a long period of low wages growth. That is what i expect, and that is why i think we end up with low rates and low inflation.

      • ssec says:

        Do you think we can have low rates and low inflation, but no recession, seeing the large household debt that must be repaid?

        • Ricardo says:

          Yep, that is what i expect. It is how we de-lever and get competitive. Hard to pay off debt with flat wages, as most have assumed rising wages in their repayment calcs. Labour market deregulation would help speed it, as it would boost competitiveness.

    • Ricardo says:

      I agree that this housing stuff mostly just changes the temporal order of events – demographics drive most of the long term housing levels stuff. Where we part is that i think the housing shell game can be played one more time. I don’t think it is desirable, but i do think it can be played again. That seems to be where we are headed.

      • ssec says:

        I am 25% for “housing shell game can be played one more time” vs. 75% not. A lot depends on what the AUD does, as you know. If AUD comes down then probability of playing the game again do increase.

        • Ricardo says:

          Actually i think that it is the opposite — if the AUD stays up, i think rising unemployment and low inflation will force them to cut rates, and then it is housing market game on

      • ssec says:

        You might be right. Right now I think we need lower AUD and further rate cuts to restart the inflationary game; just lower rates not enough.

      • Rajat says:

        Home ownership rates in Australia remained about 69-70% in 2010 (ABS 1301), as they have been for a long time. Also, household size in the 2011 census was steady at 2.6, whereas the ABS had earlier predicted a trend of declining household size reaching about 2.45 by 2011. So I don’t see some sort of bubble or speculation in home buying and as a result I don’t see the moderately rising house prices we have seen as a “shell game”. I think Chris Joye has previously noted that RP Data house prices have on average tracked nominal household income since about 2003. Since he made those observations a year or two ago, prices would have fallen relative to incomes.

        I agree with ssec’s point that confidence is at least as important as the level of rates. Where we differ is that I see monetary policy as having a central role in affecting confidence. If rates had been cut 50 bp yesterday, or had been cut in Nov as well, confidence would have improved more than it has/will.

      • ssec says:

        Then you go into thinking “if the RBA is cutting rates at record low, there must be a reason? no?” So if the RBA is “wrong” and the economy is still decent, I can see where rates will help housing (ala 2009). But if the economy really needs those rate cuts and more, it’s a different story. Even worse if they are behind the curve like you think.

        I have noticed the RBA complaining about high AUD again in the latest minutes, they must know they rate cutting is not as potent if not helped by falling AUD.

        “I think Chris Joye has previously noted that RP Data house prices have on average tracked nominal household income since about 2003.” Sorry, but that is incorrect, according to RPData it self:

        Only Sydney has been relatively stable (still increasing).

      • Rajat says:

        ssec, not sure what you mean. I said 2003, not 2001. That article only provides figures for 2001, 2006 and 2011. Try this link:

      • ssec says:

        bah, Joye is using different figures for the household income, average and population, I prefer RPData study which uses Census for household income. That’s hard data, that is not extrapolated. On a personal experience I can tell you that median house prices have at least doubled in the last 10 years in the city where I live, salaries definitely not (increased around 1.5 times).

        Most of this has happened before GFC, after GFC house prices have been around flat.

        At 6 times incomes, most cities are now at the ceiling of what is affordable and all got to Sydney level, best scenario will be house prices to track income growth to flat. Which is not much at all, and makes renting a much better alternative. So we can expect housing to contribute to growth like the last couple of years, not like before the GFC.

  4. On your Marx says:

    Banks put up higher standards following the freeze in international credit markets.

    Remember it took sometime EVEN with a government guarantee to get funding from overseas.

    IF the economy slows and interest rates continue to fall then at some stage the $A must fall.

  5. catrina smith says:

    RA does this mean your forecast was out by 100%?

    • Ricardo says:

      That would be an odd way to measure it. Most sensible people forecast in quarter points for gdp – i was a peg out. I think the reason is that i was relying too heavily on variables that are somewhat nominal. By way of example, nominal GDP was 0.2%qq, and Real GDI was -0.4%qq. This are surely the most economically meaningful numbers given the movements in the terms of trade.

  6. ssec says:

    Mining was 0.4 of the 0.5

  7. Pingback: RBA holds 3% in Feb — March cut is a 60% chance | ricardian ambivalence

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