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Markets pricing in rate hikes, economists skeptical

by | Jan 5, 2017 | property

This article was originally published by Jessica Sier via afr.com.au on the 21 Dec 2016 | Image: The markets are listening for any shift in tone from new RBA governor Philip Lowe. Louie Douvis

 

The Reserve Bank of Australia minutes this week have provoked a split between market traders and economists about the direction of interest rates next year.

 

The market believes Australia can handle a higher cost of borrowing and has lifted the chance of a rate hike in 2017 from 40 per cent to around 55 per cent. 

 

But some economists are less bullish, with ANZ and Westpac both predicting the central bank to keep rates at a record low 1.5 per cent for the entirety of 2017. 

 

On one hand, the RBA minutes offered a more positive view of the overall economy suggesting there was less of an easing bias, however the wording of the statement made clear the central bank is keeping a keen eye on household debt and the frothy property market. 

 

“They are definitely more concerned around household debt and not just in terms of financial stability but in terms of the macroeconomic implications of that,” says Felicity Emmett, senior economist at ANZ. 

“For example, if we did see a rise in unemployment because of some external shock, that could see house prices come down a bit and that could prompt a vicious circle because then there are consumer spending implications.”

 

The bank was caught between the “considerable uncertainty” in labour market momentum and the resurgent property prices in Melbourne and Sydney which prompted the board to keep rates on hold. 

 

The minutes of this month’s policy meeting also explicitly set out the board’s ongoing debate on the impact of its five-year easing cycle on asset prices and household debt. 

 

The Australian dollar has largely failed to follow commodity prices higher, providing the bank with some comfort a lower Aussie will likely allow it to continue to forecast a return to trend growth over time.

 

National Australia Bank goes even further and suspects the RBA will slice interest rates twice more in a bid to prevent unemployment rising in 2018 as housing construction slows, while the US Federal Reserve will continue to hike. 

 

“Any rise in the unemployment rate would likely see the market quickly switch to the view that still easier financial conditions are required in Australia, even as the US raises rates,” says Peter Jolly, global head of research at National Australia Bank. 

 

“NAB’s forecast sees this occurring via a combination of lower official rates and a lower Australian dollar.” 

 

There are signs the housing market is taking a breather. After two years of double-digit growth, the Sydney house price index gained only 3.2 per cent in the year to September, the weakest increase since 2012, according to the latest government data.

 

The other market giving the central bank a headache, Melbourne, saw a rise of 6.9 per cent which was the slowest in more than a year. 

 

Banks to the rescue?

One thing reducing the need for RBA to control house prices is that Australia’s banks have hiked some mortgage rates even though official rates have no moved since August. 

 

Commonwealth Bank of Australia, the nation’s largest properly lender which accounts for one in four property loans, was the most recent bank to bump up the borrowing rates for investors by 15 basis points. 

 

National Australia Bank, Australia and New Zealand Banking Group and Westpac have also raised variable rates on new and existing residential loans throughout December. 

 

“The RBA may be fortunate that perhaps the banks are already seeing their funding costs increase,” said Ms Emmett. 

 

“And some of the smaller banks have increased general owner-occupier mortgage rates and there’s potential the banks could raise further outside of the RBA anyway. That could take some of the heat out of the housing market.”