• Financial markets believe there’s a 50% chance the RBA will cut interest rates by November this year. An increasing number of economists now share this view.
• Capital Economics is the latest forecaster to predict the next move in the cash rate will be lower, predicting two 25 basis point rate cuts in the 18 months ahead.
• The RBA has expressed concern in the past that further rate cuts will simply encourage households to take on additional debt to plow into the housing market, seemingly showing little faith in macroprudential lending restrictions to avoid such a scenario.
• The RBA believes the next move in the cash rate is likely to be higher, pinning its hopes on strong economic growth to reduce unemployment and lift wage and inflationary pressures.

Like financial markets before them, the number of economists forecasting rate cuts from the Reserve Bank of Australia (RBA) is turning from a trickle into a steady stream.

Capital Economics is the latest group to joint the rate cut club, and the housing market downturn is to blame.

“We think that 2019 will be the year in which previous excesses in Australia’s housing market will catch up with the economy,” says Marcel Thieliant and Ben Udy, economists at the group.

“We believe that the deepening housing downturn will become a far bigger drag on Australia’s GDP growth than most anticipate. Rather than hiking interest rates as most anticipate, we think the Reserve Bank of Australia will have to respond by cutting interest rates later this year.”

Capital Economics sees not one but two 25 basis point rate cuts arriving over the next 18 months, the first in the second half of this year and the second in the first half of 2020.

Based on recent information, Thieliant and Udy believe Australia’s housing downturn is intensifying, increasing the likelihood of even steeper price falls and a sharper slowdown in the economy.

“Australia’s housing slump is intensifying,” they say.

“House prices fell by more than in any month in December since the current downturn started and our sales-to-listing ratio fell to a fresh record-low. That suggests that prices will keep falling at a similar pace in the first half of this year.”

Capital Economics is now forecasting that capital city home prices will now fall 15% from their previous cyclical trough, making this downturn the longest and deepest on record.

Despite strength in external trade and government demand, the group says this will place additional downside pressure on the economy.

“Dwellings investment has held up so far because there’s a large pipeline of unfinished projects but the plunge in building approvals suggests it will start to weaken soon. And households may start to curb consumption in response to falling housing wealth,” Thieliant and Udy say.

“Net exports and public investment will remain supportive but slower consumption growth will probably contribute to slower growth in business investment.”

Despite the RBA expressing a reluctance to cut interest rates further, choosing instead to keep policy rates steady in the hope that firmer labour market conditions will eventually lead to faster GDP growth, faster wage growth and inflation returning to the midpoint of its 2-3% target, Thieliant and Udy say the bank will have to change its tune, mirroring what so many other central banks have done in the past.

“The experience from housing downturns in other advanced economies is that central banks nearly always end up cutting policy rates,” they say.

Financial markets currently price the odds of a 25 basis point rate cut by November this year at 50%, a view in stark contrast to what was seen in early December last year when the same probability was attached to a rate hike over this period.

By predicting a resumption of the RBA’s easing cycle that began in late 2011, Capital Economics joins the likes of Market Economics and AMP Capital in forecasting that the next move in the RBA cash rate will be lower.

Most economists still see the next move in the cash rate as being higher, albeit not until late this year at the earliest. For several years almost all have been forced to push back when they expect RBA policy tightening to begin.

Now with an increasing number starting to forecast cuts, a greater number of forecasters mat soon follow suit. One suspects that Australian CPI and employment data later in the month could be the trigger point for such a scenario to occur, especially if weak.

In the past, the RBA has expressed concern that reducing rates further would simply encourage households to take on additional debt to plow into the housing market. While that occurred the last time the RBA reduced the cash rate in 2016, the counterargument to the RBA’s concerns is that macroprudential lending restrictions have already cooled both supply and demand for housing credit, resulting in the correction in the housing market despite relative stability in mortgage rates.

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