Why the RBA has reason to cut rates in 2019

Our resident chief economist explains why the continued drop in property prices could force the RBA to defy consensus and cut rates.

First, some global context. US Federal Reserve has hinted that it will be more dovish with regards to monetary policy from gradual and gentle rate hikes to using "...all of its tools to support the economy should that be appropriate to keep the expansion on track". Meanwhile, China's in the middle of implementing counter-cyclical money and fiscal policies to revive its slowing economy.

To these, let's include the domestic headlines. "NAB pushes out Reserve Bank rate hike forecast to 2020 from 2019" (Australian Financial Review) and "ANZ abandons its call for RBA rate hikes next year as the property downturn becomes longer and larger" (Business Insider Australia) - both published in late 2018. With cheaper equity prices resulting from last year's 7.4% negative return from the All Ordinaries index, it's risk on.

What could be more mouth-watering for investors than cheaper equity market valuation and better returns (4.5% dividend yield)?

But here's the rub. The prospect of steady interest rates as far as the eye can see (or in this case, till 2020) is borne out of the not-so-good tidings for the domestic economy.

As the RBA has pointed over the past few months, "One continuing source of uncertainty is the outlook for household consumption. Growth in household income remains low, debt levels are high and some asset prices have declined."

"Growth in household income low." While wages increased by 2.3% in the year to the September quarter (from 2.1% in the second) - this represents just half of the 4% average growth rate during the boom years preceding the 2008 global financial crisis.

"Debt levels are high". Household debt to disposable income was clocked at 188.6% of household disposable income in the September quarter of 2018.

"And some asset prices have declined". Despite this year's gain, the All Ordinaries Index remain 7.3% down from a year earlier while CoreLogic's "5 city capital aggregate" home value index has fallen by 6.6% in the year to 9 January 2019.

These would certainly put a dent on consumer confidence but more importantly, the negative wealth effect from the stockmarket and falling property prices would ripple through the entire domestic economy in terms of reduced consumer spending that, in turn, drags down overall economic growth.

Australian equities may be slowly recouping back some its losses but property prices are expected to continue to drop (by around 15%-20% from their peak).

Good news for potential homebuyers but not so good for the economy overall, especially because of property's large multiplier effect on the economy.

This explains the ANZ and the NAB's change of tune, from one to two rate hikes in 2019 to no rate hike until 2020.

But with the fall in property prices continuing, the RBA's next move on interest rates could be down rather than steady.

Read more: ANZNABReserve BankUS Federal Reserve
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