UBS: A rate cut is coming for Australia

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In the wake of Westpac’s announcement to lift variable mortgage rates for its home loan customers next month, along with the expectation that other major lenders will follow suit, UBS has altered its views on the future of Australian interest rates, predicting the RBA will cut the cash rate by 25 basis points to 1.75%, as early as its November meeting.

Here’s Scott Haslem, George Tharenou and Jim Xi, UBS’ Australian economic team:

“Asking whether the economy needs further stimulus is a very different question to ‘does Australia, today, need a rate hike or tighter financial conditions’? But that is ultimately the question we are, and the RBA will be, asking post this week’s unexpected out of cycle rate hike by one of the major retail banks.”

Pointing to the fact that the effective cash rate in the economy has now risen as a consequence of Westpac’s announcement, something that has tightened financial conditions for households, the team suggest that “unless the RBA was contemplating a near-term rate hike, the only way to return to the financial conditions to where they were at the start of this week is to offset this re-pricing by trimming the cash rate.”

Here’s a chart, supplied by UBS, identifying the tightening in financial conditions for Australian households as a consequence of higher variable mortgage rates.

As a result of other lenders likely to follow Westpac’s lead, Haslem, Tharenou and Xi expect the RBA to cut the cash rate to 1.75%, a record low, in the months ahead. Here’s their call:

“We now expect a lower cash rate, in the order of 25bp, will be needed to offset that part of the rising regulatory costs that is likely to be passed through to the household sector, whether before end-15 or in early 2016. While November 3 is by no means a done deal, we see it as the path of least regret for the RBA. However, we still hold the view the Australian economy is rebalancing better than is widely perceived, and see as less likely any adjustment in the cash rate below 1.75%.”

Earlier this week Goldman Sachs Australia forecast the RBA would cut interest rates twice in the months ahead — once in November and again in Q1 2016 — as a result of tighter household financial conditions and the likelihood of worsening drought conditions. Morgan Stanley predict a similar outcome, led by a slowdown in the housing market.

Three of Australia’s big four banks hold the view that the next move for the cash rate will be higher, not lower. The ANZ is the exception, predicting like Goldman’s that the cash rate will eventually bottom out at 1.50%.

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