So far, the RBA has pushed on a string

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Yesterday, David Uren at The Australian argued that the RBA has no concerns that it might be pushing on a string vis-a-vis its easing campaign:

The Reserve Bank is very confident that its run of rate cuts, mounting to 1.75 percentage points in the past 13 months, will bring a lift to both business and housing investment next year.

It does not accept arguments that monetary policy is losing its bite and believes it could do a lot more, if needed, to support the economy. If unemployment rises or the global outlook darkens over coming months, there will be further rate cuts early in the new year.

You would expect nothing less in public. But behind closed doors there must bit a little pause for thought. To date, the response to the -1.75% of official interest rate cuts since November 2011 has been weak, with interest rate sensitive sectors of the economy showing minimal uplift since rates were first cut.

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Indeed, compared with past cycles, the response has been historically poor. The next charts illustrate the situation by comparing the growth of key economic indicators since October 2011 – the month preceding the start of the current interest rate-cutting cycle -against previous easing cycles beginning in 1990, 1996, 2001 and 2008.

First, the growth in the value of outstanding housing credit and the value of housing finance commitments following the latest round of interest rate cuts has been around one-third as strong as the earlier episodes.

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Second, new house sales have fallen by around -20% since last October, compared with an average 20% increase in sales at the same stage of the previous three interest rate-cutting cycles:

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Third, while monthly dwelling approvals have increased at a similar rate to previous easing cycles, the overall number of approvals remains near cyclical lows on an annual basis, suggesting that housing construction will remain weak in the near term:

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Fourth, at the national level, dwelling values are lower today than they were immediately prior to the first interest rate cut in November 2011. This compares to an average 13% increase in dwelling values at the same stage of three previous easing cycles:

Fifth, the Westpac-Melbourne Institute Consumer Sentiment Index is only 0.9% above last year’s level, compared with an average 18% rise in the index at the same stage of the previous four rate-cutting cycles:

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Finally, retail sales have increased by only 3.1% since October 2011, compared with an average 6.4% increase over the four previous cycles:

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Overall, the pick-up in economic activity following interest rate cuts has been muted this time around relative to past experience, particularly in the housing sector. This suggests that monetary policy has lost some of its potency, which will likely prompt the RBA to make further deep cuts to interest rates in anticipation of the slowdown in mining investment.

How low? Well, at the moment, contrary much media commentary, we are still well above “emergency level” rates. Assuming the banks pass on 0.20% of the latest 0.25% OCR cut, the discount variable mortgage rate would still be 0.70% higher than the mid-2009 low, whereas the standard variable mortgage rate would be 0.55% higher. By the same token, the proportion of aggregate household disposable income devoted to mortgage payments would also be around 1.0% higher than existed in mid-2009 (see next chart).

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While we cannot predict how low interest rates will go, there appears to be scope for another -1% of cuts to the OCR before mortgage rates revisit their lows of mid-2009.

About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.