Opinion: Interest Rate Cuts Provide Insurance for growth


The Reserve Bank cut interest rates for the first time since August 2013 this week and while experts and pundits are all going to have a say on what this means for the future, CBRE's Head of Australia Stephen McNabb believes it points towards a positive outlook for Australia.

"The Reserve Bank of Australia has lowered the Official Cash Rate by 25 basis points to 2.25 per cent. The move marginally shifts our baseline interest rate forecast and while another move is possible if growth outcomes disappoint, we still think that rates will be increasing during 2016 as this policy action will reinforce some of the improving trends already emerging in the economy.

The decision looks more like insurance at a time that the market had already factored in the chance of a cut, rather than a large shift in growth expectations for the Australian economy, albeit the RBA's expectation that the recovery would be more prolonged and hence the economy remain below trend for longer than previously anticipated.

The decision to reduce rates was finely balanced with many indicators on the economy looking stronger now than they did when the RBA last cut rates in August 2013. For example, dwelling approvals are at peak levels of 200k per annum (compared with 165,000 in 2013), retail sales growth is running at double the pace of 2013, credit growth for business and housing has improved and non-mining CAPEX plans are also higher. Furthermore, there are a number of stimulatory pricing effects flowing through the economy including a halving in the price of oil which puts back circa $6 billion into household wallets and; the cost of borrowing at 175-200bp above the yield curve which is much lower than the 250-340bp range in 2013. The RBA stated that "this action is expected to add some further support to demand", implying a one-off action is possible.

An important element in the decision was concern that the slump in commodity prices and hence reduction in domestic incomes poses a more significant negative threat to domestic demand than the combined positives above.

The main risk from the decision is that the downward move in rates adversely impacts confidence and dampens "animal spirits" which drive business expectations – particularly at a time when the overall economic growth outlook looks reasonable, if not spectacular.
Property Impacts – More Reassuring For The Rent Cycle
There is little change to our view on core demand drivers off the back of the rate cut, although the decision provides more confidence that the cyclical recovery in office demand we expect will continue in 2016. We are also confident that the improved retail environment will be sustained (supporting rent uplift in the sector) and that the lower Australian dollar will support a recovery in the industrial, tourism and education sectors.

Bond yields moved lower ahead of the decision and at ~2.5 per cent are 70bp below their fourth quarter 2014 average. As a result, required returns on property (and other asset classes) are expected to track lower in 1H 2015 before stabilising going into 2016. This means that yield compression may be a little stronger than we previously anticipated, although we do note that there isn't a one to one impact on yields as risk may be revised up a touch and growth expectations lowered.

Higher yielding retail (neighbourhood, sub-regional and large format) and industrial look set to benefit more from the rate cut together with already expected rent cycle improvements, while prime and secondary office in Sydney and Melbourne are also better positioned to experience further compression. We view the rate cut as more neutral for Perth and Brisbane where leasing risks are higher."

Opinion by Stephen McNabb via CBRE

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