The decision from the RBA to hold the cash rate at 3.6% [4 April 2023] sends a clear message they are ready to take stock, assessing the economic impact of the rapid rate hiking cycle to date.
Considering monetary policy acts with a lag, it’s important to understand how trends in consumer prices, consumption, labour markets and sentiment are evolving as a result.
A key factor in future interest rate decisions will be how rapidly inflation falls toward the target range. Inflation peaked late last year, and based on the monthly CPI indicator, is slowing faster than the RBA’s latest forecast. The RBA forecast (from the latest Statement on Monetary Policy) has annual headline inflation at 6.75% for the June quarter, while the monthly inflation indicator suggests annual inflation has dropped to around 6.8% by the end of February.
While a pause doesn’t necessarily mean interest rates hikes are ‘done’, it is likely the tightening cycle is close to topping out. While the RBA has left the door open for further hikes, noting “…some further tightening of monetary policy may well be needed to ensure that inflation returns to target”, most forecasts have interest rates either at a peak or almost at a peak with one more hike in the wings.
An increased level of certainty around the rate hiking cycle should flow through to an improvement in consumer sentiment, which has been stuck at levels seen during the worst of the Global Financial Crisis and early phase of the pandemic. We know that consumer sentiment and housing market activity have a close relationship, so any upwards movement in spirits could see more buyers and sellers returning to the market, although we would need to see sentiment lift materially before returning to average levels.
Despite the highest interest rates since 2012, we have seen a lift in housing values over the past month; a timely reminder that interest rates are but one of the many key factors influencing housing trends. CoreLogic reported a 0.6% rise in the national Home Value Index for March, following six months where value declines were losing momentum. While we aren’t certain if March marks a turning point for housing values, it’s clear that low advertised supply, the tightest rental conditions on record and surging overseas migration are providing some positive momentum to housing markets.
The performance of housing values will be an important trend to watch, as they’re a significant contributor to household wealth. If wealth effects from higher housing values trigger more consumer spending, this may have an impact on the trajectory of interest rates.
With the cash rate setting either peaked or close to peaking, we could also see increased debate around APRA’s serviceability buffer policy, currently set at 3 percentage points above the applicable mortgage rate. Allowing for a 300 basis point rise in interest rates when assessing a borrower’s ability to service a loan, at a time when rates are already above the decade average, may be unnecessarily restricting credit availability for housing. APRA was clear in their updated assessment of macroprudential settings that the 3 percentage point serviceability buffer ‘remains prudent given the potential for further interest rate rises, high inflation and risks in the labour market’.
Whether this position changes based on the more stable interest rate outlook is yet to be seen, but any easing in serviceability policy settings (for example, reducing the buffer to 2.5% and re-introducing a 7% floor on mortgage rates) would make it easier to qualify for housing credit and likely provide an additional boost to housing sector confidence.