Macquarie sees interest rates risking 1%

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From Macquarie:

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 Two major banks have repriced mortgage rates to end borrowers, increasing the prospects of an offsetting cut at the November RBA Board meeting. Impact

 The RBA targets end borrowing rates, not the cash rate per se. With a downgrade to the inflation, and potentially growth, outlook likely at the November forecast update, we think the RBA would be unwilling to accommodate an increase in borrowing costs within the economy.

 The increased likelihood of the RBA cutting rates in November will also affect the rates equation for the RBNZ. A lower RBA cash rate will place further upward pressure on an already elevated NZ$.

 We have anticipated a Melbourne-Cup-Day rate cut from the RBA for some time. Whilst our view is based on a deterioration in the RBA’s inflation outlook, the move by a second major lender to lift end-borrowing rates increases the likelihood that the RBA delivers an offsetting reduction in the cash rate.

 The pressures on the major banks to reprice are well known. Questions of how much, and when (not if), are likely to be a focus at next week’s results briefings by the two remaining major banks that have not announced increases. The risk lies with hikes being announced over the next week.

 We had expected that the banks would reprice loans following a reduction in the RBA’s cash rate. As we noted following the first repricing last week (Aus Econ: Repricing and the RBA) the announcement before the November Board meeting now means that the RBA faces an explicit choice – do conditions in the economy warrant an increase in end borrowing rates?

 We remain of the view that the answer is no. Indeed, our assessment of the likely changes to the RBA’s growth and inflation outlook points to an economic case to cut rates – before offsetting increases in borrowing rates.

 The unemployment rate has finished 3Q15 around 20bp higher than the RBA’s forecast. Rather than peaking, the unemployment rate appears to be trending higher. The additional slack in the economy will put downward pressure on the inflation outlook.

 On the inflation front, the upcoming 3Q15 CPI data will also have significant bearing on the November Board decision and the RBA’s outlook. In addition to the weaker labour market, our 3Q15 CPI forecasts imply a lower starting point for inflation. Current levels of other key forecast inputs – the A$, TWI and Brent – do not suggest any offsetting support to a lower inflation outlook.

That risk case is, in reality, the base case for rates. Adding to the Mac Bank case, the iron ore price deck is in the process of taking another step lower. I’m not sure about November (and don’t care) but if the RBA does not cut before February it risks a nasty stall in the property market over the Summer and building downside momentum into Autumn.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.