Could interest rates start coming down soon?

Scott Kuru August 26, 2024 5 min read

Image from REUTERS by Kevin Lamarque.

KEY POINTS

Fed Reserve Chair Jerome Powell has all but confirmed the US central bank will start cutting interest rates next month
Australia’s big retail banks are not waiting for the RBA to start cutting the cash rate, with some cutting both variable and fixed interest mortgage rates to new customers
Banks have also been cutting term deposit rates, indicating they believe interest rates are heading down
Data from Westpac shows fears the Stage 3 tax cuts that came into effect in July would pump up inflation again are unfounded
Mortgage arrears have continued rising after bottoming out two years ago

Following the Reserve Bank of Australia’s (RBA) August decision to leave the cash rate on hold at a 12-year high of 4.35%, Governor Michele Bullock and her staff have been keen to dampen expectations of rate cuts any time soon.

At her post-rate announcement press conference, the Governor even went as far as ruling out rate cuts until February next year, saying financial market expectations of rate cuts “by the end of the year and the next six months” didn’t align with the board’s “thinking about interest rate reductions at the moment.”

However, several recent economic and financial developments have called into question the RBA Board’s “hawkish” attitude and appear to pave the way for interest rate cuts in Australia before the end of the year.

The signal from the US Fed

Last Friday, the world’s most influential central banker, US Federal Reserve Chairman Jerome Powell, all but confirmed that the Fed will cut interest rates at its next monetary policy meeting in September.

“The time has come for policy to adjust,” he said.

“The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”

As in Australia, the US central bank has been waging a battle to get inflation down after it shot up to 7%, but Jerome Powell said his “confidence has grown that inflation is on a sustainable path back to 2%.

His focus now is to protect jobs, with indications unemployment in America is rising fast.

Rates in the US are at a 25-year high in the 5.25-5.50% range.

Markets are now busy speculating whether the Federal Reserve will cut rates by 0.25% or a “supersized” 0.5% cut at its September meeting.

While rate cuts in America won’t necessarily translate into rate cuts here, Mr Powell’s comments are a very clear indication that the inflation breakout that has plagued major Western economies in the wake of the COVID-19 pandemic is coming to an end.

Global cuts

Central banks in Canada, New Zealand, Britain, Switzerland, and Sweden have cut their cash rates and there’s growing expectations the European Central Bank will cut rates again in September.

Retail banks not waiting for a cash rate cut

While the RBA continues to talk tough about maintaining a hard line against inflation and trying to dampen expectations of a cut in official rates anytime soon, some of Australia’s big banks aren’t waiting for the central bank.

In what some commentators have described as “reigniting the mortgage wars,” the nation’s biggest lender, Commonwealth Bank, has cut variable rates offered to new customers by 0.2% to 6.49% if they have a 20% deposit.

It’s also cut 0.7% off its three-year fixed rate offering to 6.04%.

Rivals Westpac and NAB have already cut some fixed-rate loans to 6.29% and 5.99% respectively.

At the same time, banks have been trimming the rates on term deposits offered to savers.

An analysis by comparison site RateCity.com.au for the ABC found that since the start of August, 23 Australian banks have cut interest rates on at least one of their term deposits, including Commonwealth Bank, NAB, and ANZ.

The implication is clear—the banks believe interest rates are heading down soon, and they are moving preemptively to shore up their market share before the RBA cuts rates.

Westpac spending and savings data and mortgage arrears

New data from Westpac also provides some interesting evidence about the weakness of the economy and the muted impact of the government’s Stage 3 tax cuts on inflation.

Westpac says the cuts, which came into effect from July the 1st, provided the average earner with “an estimated $220 boost in July” with “other income drivers” adding a further $860.

The “other income drivers” include higher wages (as many annual pay rises kick in from July 1st), increases in hours of work or bonus payments.

However, using data gleaned from about a million Australians, Westpac Economist Jameson Coombs says that “preliminary evidence suggests the boost to income from Stage 3 tax cuts has had very little flow on impact to consumer spending.

“Higher after-tax income has instead been directed towards savings, in the form of both deposits and mortgage offset accounts.”

Speaking of mortgage offset accounts, the RBA has made much over the past few years about the substantial “savings “buffers” Australians built up during the pandemic and how this has helped many households with variable mortgages stay afloat as interest rates spiralled higher and higher from the pandemic emergency cash rate of 0.1%.

However, news.com.au reports figures from the financial regulator show that cash held by Australians in deposits “has been decreasing—from $374bn in April, to $328bn in May, to $261bn in the latest figures for June.”

Home loan

At the same time, mortgage arrears rates are ticking up again.

The number of Australians who have been seriously falling behind and defaulting on their mortgage repayments bottomed out in 2022, but has been rising ever since.

This is a very real sign of pain in the economy and evidence that the RBA’s decision to lift rates no less than 13 times since May 2022 in a bid to squash inflation is working.

Money markets ignore the central bank

Despite Michele Bullock telling them not to get ahead of themselves when it comes to the timing of any future rate cuts, money markets have shrugged off the RBA Governor’s warning and are instead betting there will be at least one 0.25% rate cut this year.

They’ve also nearly fully priced in another cut by the time the RBA’s scheduled meeting in February rolls around and almost another two by the end of September next year.

Cash rate

The traders who bet millions of dollars on the future movements of interest rates have looked at all the evidence, both here and overseas, and have concluded that despite its tough talk, the RBA’s hand will be forced in order to stop Australia falling into a recession.

They believe the only direction for interest rates is down, and that will happen sooner rather than later.