2019-10-22 09:47:261970-01-01 00:00:00

Rate Cut

RBA, the reserve bank of Australia, is the Australian central bank. One of its biggest roles is to manage Australia’s federal interest rate, with a consideration of the economic information including the unemployment rate, inflation rate, and housing price. The adjustment on the RBA interest rate would have a ripple effect on the entire economy.

As the economic growth slows and the inflation rate remains at a low level, it is widely expected that the cash rate will fall. The rise in the unemployment rate (to about 5.2 percent) in April may be the last evidence that the RBA needed to cut the interest rate. After a month of forecast and speculation, the RBA Governor Philip Lowe gave a speech on May 21, 2019, to claim that RBA would possibly reduce the interest rates next week. The decision hopes to break RBA’s long-held record of holding the interest rate at 1.5 percent for the 30th consecutive time. This is a major and rapid shift, considering the federal bank was planning to raise the cash rate last year. However, the economic slowdown changed the bank’s mind to increase the cash rate.

As reported in the Australian Financial Review, in response to the RBA’s introduction of a quantitative easing bias, Bill Evans, a chief economist at Westpac Banking Corp (ASX:WBC), believed that there may be three rate cuts from now until November 2019, which means interest rates will fall to 0.75%.

Impact on the housing market

Australian house market has remained fairly weak as the property price in the Australian major cities fell by 10 percent over the past 18 months. Especially in Sydney and Melbourne, the house prices fell by 0.7% and 0.6% in April; CoreLogic data released earlier this month showed an annual decline of 10.9% and 10% respectively in Sydney and Melbourne. Moreover, the capital cities of New South Wales and Victoria fell by 14.5% and 10.9% respectively from their highest point in July and November 2017.

Interest rate cuts refer to the changes in the cash rate adjusted by the central banks. When interest rates decrease, the interest earned from depositing funds into banks is reduced. Therefore, interest rate cuts will cause funds to flow out from banks, and deposits will be withdrawn to become capital for a better investment. This would eventually increase the liquidity in the Australian financial market, which will provide an incentive for the corporates to increase their loans for future reproduction and encourage the consumers to purchase large commodities; thereby boosting the domestic economy.

Specifically, for the property developer in the housing market, interest rate cuts would reduce their financing costs and improve their new property development capabilities. Housing buyers can be divided into self-occupied and investment-oriented. For self-occupied homebuyers, interest rate decreases are a preferential policy that reduces their burden on the house loan. In terms of investment-oriented buyers, a drop in the interest rate would discourage investors from over-investment in properties and price speculation.

After RBA announced the interest rate cut, it is widely believed that the interest rate decrease decision will be a direct remedy and a correction for falling house prices. Therefore, a reduction in the cash rate could possibly be related to the remarkable reverse in the falling house price last week.

The real estate market in Sydney and Melbourne showed early signs of ending its steep slides, as the auction clearance rate rebounded sharply in last Saturday.  Prices in these two major cities have also risen, which offset the decreasing trend in the first half-year. According to CoreLogic, Australia’s initial consolidated capital clearing rate increase to 62.6%, which was a significant growth from the 57.0% that recorded seven days ago. About 2,041 houses were sold during last week, which was more than double of the previous weekly record of 917.

The concerns with the rate reduction

Even though the reduction policy can be a tool for stimulating the development of the economy, it can not be described as a piece of good news. It would be unusual for RBA to cut the interest rate when the country is experiencing an economic boom. The central bank will decrease the rate if they are concerned about an economic downturn.

Moreover, it is a public concern that the policy may not be able to effectively respond to the housing market condition immediately. Take Western Australia as an example, house prices in Western Australia had fallen longer than other regions, and consumer spending was declining. This is circumstantial evidence that as house prices fall, savings will rise over time. In this case, the lower interest rate and the quantitative easing policy would limit the drop in house prices. However, it is unclear whether the impact on the change in house prices can prevent a sharp rise in savings, which is an indication of a possible recession. Thus, whether the consumer confidence in the real estate market is low or high, in addition to adopting relevant fiscal policies, the state needs to consider the application of administrative means.

By Louis Cai

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