2024: The year of three interest rate cuts or just one?

Since late last year, most banks, economists and the financial markets have been predicting that interest rates have peaked, and the central bank will start cutting rates this year, offering relief to thousands of households battered by higher mortgage repayments.

This comes after the Reserve Bank of Australia hiked the cash rate no less than 13 times, starting in May 2022, in a bid to bring inflation down.

Most - including the financial markets - had been predicting there would be at least two rate cuts of 25 basis points (0.25%) this year, with some forecasters even stating they expected a first cut as early as May.

That’s all changed in the last week, though, with a clear split emerging between the financial markets and some forecasters and, on the other side, the economics team at Australia’s largest mortgage lender, the Commonwealth Bank.

Interestingly, a lot of this gap has to do with differing views of how much impact global economic events will have on Australia. 

So what’s happened? 

The simple answer is that the world’s biggest economy is not slowing fast enough, and there are fears that inflation in the United States could take longer than expected to come down from the highest levels in a generation. 

The US inflation measure dropped to an annual rate of 3.1% in January 2024, according to official data released last week.

The problem was that economists were expecting it to come in at 2.9%.

While US inflation is lower than in Australia (the December quarter CPI here came in at an annualised 4.1%), interest rates in the US are higher (5.25% to 5.50%). The Federal Reserve started hiking rates much earlier than the RBA in a bid to get core inflation back to the Fed’s 2% target.

Wall Street reacted with a sell-off, and bond yields jumped as markets started pushing back the timing of rate cuts in the US to July.

Only a few weeks ago, markets had been optimistic about a rate cut in America as early as March.

An elephant sneezes…

While there seems to be no debate that the Fed Reserve is not going to raise rates again, it’s clear the battle against US inflation has not been won.

Not only did the markets push out the chances of a rate cut in the US, but they also pushed out the timing for rate cuts in Australia from the current cash rate of 4.35% as well.  

These graphs show market expectations for Australian interest rates on the 9th and 15th of February:

As you can see in the first graph, markets had priced in two full 25-basis point rate cuts by the end of 2024, with the first in August.

In the second graph, just hours after inflation data had been released in the US, you can see spooked markets were pricing in just the one cut, in December.

The rationale for the markets’ view is pretty simple:

Australia started raising rates to tackle runaway inflation after the US, and therefore, if it takes authorities in America longer to get inflation back to target there, it will take the RBA longer here.

The contrary view 

Australia’s largest bank - the Commonwealth - runs the largest home lending mortgage book in the country.

They’ve actually doubled down on their prediction from late last year that there will be no less than 3 interest rate cuts of 25-basis points by the RBA this year.

“The Australian economy has slowed much more quickly than the US economy over the recent past,” says CBA’s Head of Australian Economics, Gareth Aird.

“Real household income has been hit much harder in Australia, consumer spending is much softer and the labour market is loosening more quickly.”

Mr Aird is particularly worried about the number of people losing their jobs and people working fewer hours, underlined by the latest ABS statistics, which showed a seasonally adjusted increase in unemployment in January to 4.1%, up from 3.9% the previous month.

Given that most US homeowners are on long-term fixed interest rates, not variable rates like in Australia, Gareth Aird notes, “the monetary policy transmission channel via the mortgage market is much more direct in Australia.”

He says that means the RBA will need to cut rates in the second half of the year to stop the unemployment rate rising above 4.5%.

The CBA also believes inflation in Australia is coming down faster than many think, predicting so-called “underlying inflation” will be at the top of the RBA’s target 2-3% band in the second half of the year.

Mr Aird says the CBA expects the RBA to start cutting rates in September and has factored in no less than 75 basis points in cuts (or three 0.25% reductions) by the end of the year.

But it won’t stop there.

The CBA is predicting the RBA will have to cut rates three times in the first half of 2025 in a bid to avoid crash-landing the Australian economy, taking the cash rate down to 2.85%.

Gareth Aird’s view has received strong backing from outspoken Macrobusiness analyst, David Llewellyn-Smith, who says the (contrary) “consensus notion that the RBA will cut the cash rate later and more slowly than the US Fed is laughably wrong.”

“The RBA will be forced to pivot hard, slash and burn while the Fed can take its good time,” he says.

The implications for the housing market 

High population growth, low rates of new home completions, and a chronic housing shortage mean that home prices have largely shrugged off continual interest rate increases by the Reserve Bank.

CoreLogic figures show national home values grew an impressive 8.1% last year.

Investment bank Jarden has said it believes each 50 basis point (or 0.5%) cut in the RBA cash rate translates into a jump in value of 4 to 5% for house prices.

If the CBA is right with its prediction of 6 RBA interest rate cuts by July next year, totalling 1.5%, the outlook for the property market in 2024 and into 2025 is decidedly bullish.