Barrage of interest rate cuts may be just around the corner
The economy is at a turning point, with inflation seemingly heading back to its target range and an economic soft landing unfolding, so what does this mean for interest rates in 2024 and beyond?
Given the resilience in local and global economic growth over recent months - along with continued steady declines in inflation - it appears increasingly likely that a soft economic landing is probable this year.
In Australia, the December quarter consumer price index had dropped to 0.6 per cent on a quarterly basis, and to 4.1 per cent on an annual basis. The domestic rate of inflation has halved over the past 12 months.
Moreover, the 4.1 per cent recent annual result was much less than the 4.5 per cent forecast by the Reserve Bank for calendar 2023.
They've been kept on hold in the first RBA decision of 2024 but where to next for interest rates?
String of rate cuts possible
Well – at this stage – a increase in the cash rate is very doubtful. Falls in the cash rate are more likely.
The financial markets have been expecting them to fall from late in the year and the betting is now strongly in favour for the first fall to be between August and December this year. If things economic go further south than anticipated the first cut could be a soon as May.
My modelling suggests that six separate 0.25 per cent falls in the cash rate are possible between mid-to-late 2024 and by the end of calendar year 2025.
Right now, the first 0.25 per cent cut is likely to be in August 2024, a month after the Australian Bureau of Statistics quarterly consumer price index result. Further cuts are likely to follow the same pattern after the official quarterly CPI result.
If this eventuates then the Australian cash rate is likely to fall from its current 4.35 per cent to 2.85 per cent by late 2025, a fall of 1.5 per cent.
We all know that most of the hikes in official interest rates are passed onto borrowers. At present the average pass-on rate across all financial institutions has been 85 per cent. History shows that only around 80 per cent of rate cuts are transferred to deposit holders.
Assuming that history repeats, then a 1.5 per cent fall in the cash rate should see mortgage rates fall by around 1.2 per cent.
This will drop the average new home loan to owner occupiers from 6.23 per cent today to around 5 per cent by late 2025. New property investment loans are likely to fall from their current 6.6 per cent average, to 5.5 per cent or thereabouts.
It may be prudent to anticipate that variable mortgage rates are likely to remain around the 5 per cent mark for some time to come.
What could change interest rates’ trajectory?
Of course, risks remain.
It’s still possible that the lagged impact of past interest rate increases catches up with the economy, especially as more households and businesses are forced to refinance cheap Covid-era loans at higher rates.
With the recent rise in unemployment this outcome looks possible. But this would mean the central bank cuts the cash rate deeper and faster than our forecast as outlined above.
A more troublesome risk is if the current decline in inflation starts to slow, with wages and service sector inflation remaining too high. It doesn’t help matters in this regard while government largesse is still very much in play.
Another risk is geopolitical – an escalation in the conflicts in the Middle East and Europe – that pushes up inflation through the disruption of critical global food and energy supplies. As we also know, Chinese tensions with Taiwan also persist and the potential re-election of Donald Trump at the end of this year remains a wild card.
So far at least, geopolitical tensions remain contained but time will tell.
My reading of the tea leaves – for now – is that the next movement in the cash rate is down and is likely to fall many times, in small progressive cuts, over the next 12 to 18 months.
This will see the demand for property rise.
