RBA is certain to say on hold - Westpac

Analysts at Westpac noted that the Reserve Bank Board meets tomorrow on November 7 and they said that the Board is certain to keep rates on hold.

Key Quotes:

"In previous years November has been a very popular month for changing rates but not this year.

Rates have not been adjusted in November since 2011. However in the six years from 2006 to 2011 there was a rate move at every November Board meeting.

In recent times, November has also been a popular “target" for market expectations of rate moves. Following the rate cut in August last year, markets were confident that there would be a follow up cut in November – Westpac was not convinced with that view and the November meeting passed with no change.

Some months ago, offshore investors assured me that the Board would adopt a tightening bias at the November meeting. That prospect has since dissipated.

Later today, the Australian Bureau of Statistics will release the revised weights for the Consumer Price Index. This is a five year event (now to be revisited every year) and, in the past, has seen the revised weights lead to a reduction in the CPI of around 0.2 percentage points over the year. Another downward effect is almost certain as spending patterns evolve towards those components that have fallen in terms of relative prices. Westpac expects the revised weights to reduce the outlook for inflation over 2018 by 0.4 percentage points for headline inflation and 0.3 percentage points for underlying inflation. Note that historical inflation estimates will not be affected.

The Board will have the opportunity to review the Bank’s own assessment of the revised weights on the inflation outlook at the meeting on Tuesday.

It is also likely to take a closer look at developments in residential property markets – particularly Sydney.

Note that the Governor’s Statement following the October Board meeting included, "In Sydney, where prices have increased significantly, there have been further signs that conditions are easing”.

Recent data shows that six month annualised inflation in the Sydney market has fallen from 22% at January this year to –0.7% in October. Of particular interest for the Sydney market is going to be the behaviour of investors going forward.

Conditions for investors appear to be deteriorating.

For a start, banks have raised interest rates for investors through 2017. Headline rates for interest only investor loans have been increased by around 75 basis points; while headline rates for principal and interest investor loans have been increased by around 30 basis points. These increases follow the moves in 2015 of 45 and 38 basis points respectively. Lending guidelines have also been tightened with expenses being more closely scrutinised and non-wage incomes more heavily discounted.

The most recent changes have been in response to APRA’s direction to the banks to slow the growth in interest only loans to 30% of flows.

Land taxes and municipal rates are also challenging investors as these imposts increase in response to the recent boom in land values in Sydney. Some investors report that land taxes, in an environment of low rental growth (the rent component of the Consumer Price Index rose by less than 1% over the last year) are claiming up to 40% of rental income. Average gross rental yields in Sydney are around 3.5%.

State government stamp duties for foreign investors have been boosted by around 7-8% (although other countries have been more aggressive – Toronto; Vancouver; Hong Kong and Singapore have established “aspirational” levels of 15%).

Some investors may also be unnerved by other aspects of government policy.

The 2017 Commonwealth Budget excluded depreciation allowances on used apartments while “inspection travel” deductions were banned.

Investors are also concerned the NSW state government might aim to strengthen the rights of tenants with limits on rent increases; making evictions more difficult; and imposing longer rental periods.

Superimposed on all these concerns are the stated policies of the Federal Opposition.

In the July 2016 election the ALP indicated that, if elected, from July 1 2017 negative gearing would only be available for new investments. The capital gains tax discount of 50% would be reduced to 25% from July 1 2017.

Neither change was ear marked to be retrospective and would therefore only have applied to investments made after July 1 2017. With another Federal election due in 2019 and the ALP holding a sustained and commanding lead in the opinion polls, investors will be making decisions on the basis of this potential change in tax policy.

We cannot discount the possibility of investment activity being brought forward to take advantage of the "grand fathering" of the ALP’s policies, although the other headwinds which have been discussed above are likely to contain any “bring forward” effect.

Dominating the investors’ decisions’ will be prospects for capital gains. With price momentum easing, those prospects will be decidedly unattractive to investors.

It appears that the prominent role of investors in the Sydney market is already dissipating and that is likely to continue. That process can only continue to ease pressure in the Sydney market, with the most likely outcome being a long period of flat prices.

What does this mean for interest rates?

The Reserve Bank has indicated that interest rates will be targeted at inflation and growth while macro prudential policy will address financial stability.

Current trends indicate that financial stability concerns will be easing for the Bank.

That suggests that a further “round” of macro prudential policies will not be necessary.

Interest rate increases that might accelerate weakness in real estate markets which might have a spill over impact on confidence and spending will also be unattractive.

However, interest rate cuts to head off a more severe adjustment in housing markets still seem quite remote."