An Official Interest Rate Cut In 2015 Is Rapidly Becoming A Believable Scenario

Hybrid House by Tasmin Salehian is displayed during the 2014 Sculptures by the Sea exhibition in Sydney. Cameron Spencer/Getty Images

A growing group of authoritative voices now believe an official interest rate cut, and not a rise, is on the agenda for 2015.

Until less than two weeks ago, the collective voice of market economists had been forecasting a tightening in monetary policy — a small rise in rates — sometime late next year.

What’s changed to switch thinking from an interest rate rise to a cut?

There’s concern about rising unemployment added to an apparent slowing in residential housing growth and yesterday’s official GDP numbers, which show a weakening in economic growth to about 2.7% from 3.2%.

Credit Suisse was the first, in a note to clients, to say: “The RBA needs to cut rates further – either to boost housing demand, or to minimise the damage from a cyclical slowdown. Shallow rate cuts are supportive of the dividend trade in the equity market and de-equitisation. Deep rate cuts are a risk-off signal, favouring defensives.”

The evidence for RBA moving closer to cutting rates comes from a recent speech by RBA Governor Glenn Stevens that the present focus of monetary policy is to lay a platform for an upswing in residential investment to counteract the fall in mining investment.

What the RBA doesn’t want is for both residential and mining investment to slow at the same time.

The RBA has officially stated it’s concerned about big gains in Sydney and Melbourne house prices, compared to the other capital cities, and strong growth in investor activity.

Both the RBA and APRA (Australian Prudential Regulation Authority) have said they will look at regulations targeting investors by the end of 2014.

“Official rhetoric suggested that regulation could be used to contain housing market speculation and house price inflation, rather than rate hikes,” Credit Suisse says.

“However, RBA Governor Stevens is now saying that macro-prudential regulation is not being considered as a ‘non-rate’ tightening option, because the goal of policy is not to dampen the housing market.

“Rather, light macro-prudential regulation is being considered as a tool for ensuring a sustainable upswing in housing demand and construction.

“We interpret these comments to mean that the Bank is prioritising growth over financial stability. It sees growth as the key to financial stability. Arguably, the Bank sees the risk of macro-prudential regulation having too much of a negative impact on growth, and therefore is suggesting that we need to take a step back.

“The question is whether the conditions are in place for a multi-year upswing in residential investment. In our view, they are not. Therefore, the RBA has more work to do. We continue to believe that the RBA will cut rates below 2%. The first step on the path to easing was to not implement macro-prudential tightening. We think that outright rate cuts are next.”

On Tuesday this week, Deutsche Bank announced it now expects the RBA to cut interest rates next year by as much as 0.5 percentage points in two moves.

It based the call on a deterioration in employment and declining activity in housing.

And now Goldman Sachs Australia has moved its thinking after the weaker than expected official GDP numbers.

Goldman Sachs says it is shifting its view to an interest rate reduction in 2015.

“We still think that GDP growth is on track to average 2.9% in 2014 (consensus 3.1%) and 2% in 2015 (consensus 2.9%),” says Goldman Sachs in a note to clients.

“Nevertheless, revisions to the back data and the composition of the GDP data were sufficiently poor to tilt the balance of probabilities towards a rate cut.”

The cut could come in the first half of 2015 in about March by 0.25 percentage points and again in August by 0.25.

This would bring the cash rate down to 2%, the same level forecast by Goldman Sachs.

“We expect the RBA will leave interest rates unchanged until 2Q 2016 when we expect the RBA to commence a tentative tightening cycle,” Goldman Sachs says.

Australian interest rates are at their lowest level in 60 years. The RBA hasn’t moved rates for 15 months in a row.

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