Why an Interest Rate Cut Won’t Save Property Prices

Yesterday the Reserve Bank of Australia (RBA) held fire on interest rates.

That makes it the 33rd month in a row of no change.

For a job with literally one task, the bigwigs over at Martin Place may as well as went on leave for three years!

Perhaps they have?

Has anyone checked…?

The RBA last awoke from their slumber back in August 2016 when they cut the cash rate to its record low of 1.5%. But the strong feeling right now is that they’re just delaying the inevitable with yesterday’s decision.

The next move — the experts tell us with confidence — will definitely be down.

We’ll see, I suppose.

Call me cynical, but I remember around this time last year the ‘expert’ view was that the next move on interest rates was ‘definitely’ upwards.

Anyway, the reasons for the current chorus of cut calls this time are growing…

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Sending out an SOS

First of all, there’s the general air of angst about the state of the world economy. And a feeling that interest rates need to get ahead of any coming crisis.

For a while, this wasn’t born out in the figures. In fact, many of the economic indicators around unemployment, economic growth and inflation are within their target ranges around the world.

But we’re finally starting to get some numbers in that are confirming the worst fears of the doomsayers…

A 20% fall in Chinese exports announced last month was a major warning sign. The Chinese economy is a huge barometer for global trade these days.

And with President Trump just declaring out of the blue on Monday that 25% tariffs is about to be put on another US$325 million worth of Chinese exports by the end of the week, the fear factor just ramped up a notch.

Make no mistake, if China sneezes Australia will be catching a cold or even worse. Our island nation of mining exports is leveraged to Chinese growth more than ever before.

Domestically, some of our banks are putting out the same message to the RBA governor. But for different reasons.

For banks a rate cut will help their profit margins on existing loans by lowering the cost of deposit funds (as I don’t think they’ll pass on in full any rate cuts to poor mortgage holders), but they’re also hoping it will get the economy — and therefore lending — going again.

Shayne Elliott at ANZ said last week:

I think the argument for a small rate cut is sound.

Maybe a rate cut would be a good thing, put a bit more juice into the economy and put a few more people in employment.

Interestingly, his counterpart at NAB disagreed. NAB CEO Philip Chronican stated at the recent half-yearly reporting meeting:

Whether or not there is an interest rate cut I don’t think it will have much effect and I don’t think that the last two had much effect either.’

Perhaps the effect of an interest rate cut is a double-edged sword for banks at the moment? It may push down cost of funds, but it might also ramp up the fear factor by signalling we are indeed in trouble.

An eager onlooker into all this rate cut talk is, of course, property investors…

When do the falls stop?

As you’ll know, Aussie home prices are falling.

The million-dollar question is: is this just a natural correction after two decades of stunning growth? Will we get a so-called ‘soft landing’?

Or is it the start of something a lot more dramatic?

According to Digital Finance Analytics Chief, Martin North, it’s not going to be pretty:

“Prices will unwind in Sydney and Melbourne for at least another three years,” he says. “The problem is a lot of the high level data is averaged and averaging tells you nothing at all. Prices are not dropping by the same rates everywhere.

In some places, for example western Sydney, prices are 23 to 25 per cent down or more, but areas closer into the city, particularly houses, are probably only 3 to 5 per cent down.

To make matters worse there’s a strong probability of an incoming Labor government about to be elected on a platform of negative gearing and capital gains reform on property.

With that kind of talk it’s no wonder investors want an interest rate cut pronto. Anything to increase demand for property and help support prices — or at least slow the price falls.

But I don’t think that’ll work.

Here’s why…

Crunch then collapse?

What’s really driving down the prices of property right now is a post-Royal Commission crunch in credit availability.

It’s not that the banks don’t have money to lend.

It’s that they’re constrained by a new-found focus on ‘responsible lending’. Sounds a bit weird, I know. I mean, isn’t that business as usual for the banks?

Well, as the Royal Commission laid bare, it clearly wasn’t. We had a system of easy credit with little attention paid to such trifling matters as a person’s ability to repay.

As a former Lending Executive, I find that astonishing, but also in a way, not very surprising. The corporate banking system is built on credit growth. Everyone’s bonuses from the CEO down to the branch manager are based on pushing out more and more loans.

So, where’s the incentive to be cautious?

After all, it’s not your money you’re lending, and the government has shown it’s ready to step in and bail everyone out should the worst come to worst.

In short, there was a culture of ‘make hay while the sun shines’.

At least that was the way it was…

The world changed after the Royal Commission into banking. And banks have done a complete 180 now.

There are reports that a newfound strict interpretation of lending laws is resulting in huge delays in mortgage processing times. Banks now want to know all about you before they lend. Right down to how many takeaways you had last week!

Because if they don’t, the regulator will be after them.

ASIC is in the midst of taking Westpac to court for ‘irresponsible lending’.

According to ABC news:

ASIC accused Westpac of breaking the law when it approved loans using the Household Expenditure Measure (HEM) — a relatively low estimate of basic living expenses — rather than customers’ actual declared living costs in its automated loan approval system.

This demand for more information is having a direct and measurable impact on how long the approvals process is taking.

The data shows that the average time from submission to settlements has blown out from 39 days pre-royal commission to 62 days.

And the basic fact is, banks aren’t lending as much to each borrower as they used to.

Now, why won’t an interest rate cut help here, you might be thinking?

Well, the thing is the banks are under an obligation to assess your ability to repay at an interest rate of 7.25%. Regardless of the true interest rate.

That’s almost double current interest rates! There are calls to cut this ‘assessment rate’ to 6.75%, but I can’t see how that will make too much difference to lending amounts.

With the double impact of more scrutiny when it comes to expenses, and an assessment rate double the real rate, I simply can’t see what a 0.25% or even a 0.5% cut to interest rates will do for the property market.

If the banks even pass it on…

The fact is buyers can’t meet sellers’ inflated expectations because, even if they wanted to, the bank won’t lend them the same amounts they have in the past.

This credit crunch is going to filter out into property prices for a long time yet.

On the positive front, this could make property an affordable option for a bunch of first homebuyers who were increasingly shut out from ever getting the chance to own a home.

A return to the ‘Great Australian Dream’ perhaps?

That will rely on employment staying relatively stable and a period of sideways movements in property prices. The ‘soft landing’ scenario.

But if we get a slowdown in China this year, or some other global economic shock, this current credit crunch will turn into a property price collapse. And no one wins in that scenario.

Plan accordingly…

Good investing,

Ryan Dinse,
Contributing Editor, Money Morning

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Ryan Dinse is a contributing Editor at Money Morning. He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur. With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle. Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.  


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