Interest rates
Given the resilience in local and global economic growth over recent months - along with continued steady declines in inflation - it appears increasingly likely that a soft economic landing is probable this year.
In Australia the December quarter consumer price index had dropped to 0.6% on a quarterly basis, and to 4.1%, on an annual clip. The domestic rate of inflation has halved over the past twelve months.
Moreover the 4.1% recent annual result was much less than the 4.5% forecast by the Reserve Bank for calendar 2023.
So where to next when it comes to interest rates?
Looking forward
Well – at this stage – a increase in the cash rate is very doubtful.
Falls in the cash rate are more likely.
The financial markets have been expecting them to fall from late year and the betting is now strongly in favour for the first fall to be in August this year. If things economic go further south than anticipated the first cut could be a soon as May.
Our modelling – in conversation with independent property analyst Michael Matusik - suggests that six (6), 0.25% falls in the cash rate is possible between mid-to-late 2024 and by the end of calendar 2025.
Right now, the first 0.25% cut is likely to be in August 2023, a month after the Australian Bureau of Statistics quarterly consumer price index result. Further cuts are likely to follow the same pattern, being in the first Tuesday of each month, after the official quarterly CPI result.
If this eventuates then the Australian cash rate is likely to fall from its current 4.35% to 2.85% by late 2025. A fall of 1.5%.
We all know that most of the hikes in official interest rates are passed onto borrowers, yet history shows that only around 80% of rate cutes are transferred to bank customers.
Assuming that history repeats, then a 1.5% fall in the cash rate should see mortgage rates fall by around 1.2%.
This will make drop the average new home loan to owner occupiers from 6.23% today to around 5% by late 2025. New property investment loans are likely to fall from their current 6.6% average, to 5.5% or thereabouts.
It may be prudent to anticipate that variable mortgage rates are likely to remain around the 5% mark for some time to come.
What could change?
Of course, risks remain.
It’s still possible that the lagged impact of past interest rate increases catches up with the economy, especially as more households and businesses are forced to refinance cheap Covid-era loans at higher rates.
But this would mean that the central bank cuts the cash rate deeper and faster than our forecast as outlined above.
A more troublesome risk is if the current decline in inflation starts to slow, with wages and service sector inflation remaining too high. It doesn’t help matters in this regard whilst government largesse is still very much in play.
Another risk is geopolitical – an escalation in the conflicts in the Middle East and Europe – that pushes up inflation through the disruption of critical global food and energy supplies. As we also know, Chinese tensions with Taiwan also persist and the potential re-election of Donald Trump at the end of this year remains a wild
card.
So far at least, geopolitical tensions remain contained. But time will tell.
The reading of the tea leaves – for now – is that the next movement in the cash rate is down and is likely to fall many times, in small progressive cuts, over the next twelve to 18 months.
This will see the demand for property rise.
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