ECONOMY - A rate cut...but so what?

Shane Oliver writes it will take a few more rate cuts by the Reserve Bank to get the property market going again

When the Reserve Bank announced a 25 basis point cut to the official cash rate earlier this month, it came as no surprise. But – like the race that stopped the nation – it was certainly a close call.

The RBA didn’t reveal whether there would be more cuts, but I think the risks are skewed toward the downside.

In terms of the property market, the cut does provide the support we need, given the softness in sales prices and auction clearance rates. That said, I don’t think 25 basis points is enough to boost activity.

The cut might help slow the rate of decline, but don’t forget we had one day of good news on interest rates but bad news continues to flow in from the rest of the world. The share market has been underperforming, worries about Greece and the rest of Europe persist and the data coming out of America and China are relatively soft.

The news overall remains pretty bleak and I don’t think one rate cut is enough to offset that.

I believe Australian consumers will remain pretty cautious. We might see a bit of a bounce back in confidence, but that will just be a temporary blip and the broader picture will reflect caution. I really think two or three successive rate cuts are needed to spark an improvement in the property market.

Inflation looks to have been the key to the Reserve Bank’s decision. The RBA focuses on its inflation targets and the main reason it gave us the 1 November cut was that it was looking for underlying inflation to go to the top of the target range.

The RBA is now looking at it hovering around the middle of the target range.

Of course, what’s going on in Europe as well as domestically has a significant bearing on that because if growth is weak, it means less pricing power and a lower threat of inflation.

If Europe continues to worry investors and to threaten the global economy, then that could support an argument for more rate cuts.

If inflation remains benign it provides more scope for more moves, but in the short term I would suspect – short of some sort of financial meltdown in Europe – that the Reserve Bank will leave rates on hold in December.

In January, there is no meeting, which means the next opportunity to look at rates will be in February. That, incidentally, will come just after the release of the December 2011 quarter inflation results.

If we are going to get more rate cuts, we probably won’t see them until February or March 2012.

In the meantime, a 25 basis points cut is certainly nothing to write home about.

Historically, a few cuts have been needed to get the market turning again. Investors tend to hang back a bit, more because they want to see evidence that momentum is building in terms of prices.

Investors’ enthusiasm – whether it’s for shares or for property – generally peaks after there has been significant capital growth. At the moment, however, the trouble for investors is that yields are really not that flash.

If you look at data from the Real Estate Institute of Australia, yields are about three per cent on houses and four per cent on units. RP Data/Rismark has it slightly higher, but that’s a gross yield so you have to subtract costs.

So, you’re probably looking at yields of one to two per cent net rental yields on houses and two or three per cent on units.

With yields this low, it really takes a lot to get investors back into the market, whereas owner occupiers or first home buyers see things differently – they buy a house for shelter.

I would expect that investors will still be sitting around for quite a while.

By Shane Oliver, AMP chief economist