RBA's 'restrictive' stance leaves rate path finely balanced

The Reserve Bank of Australia has given borrowers an important reason to hope that the current interest rate cycle is nearing its peak, but a senior RBA official’s assessment of financial conditions also makes clear that a rate cut remains some way off.

Speaking in Sydney on Thursday, Christopher Kent, the RBA’s Assistant Governor (Financial Markets), said the cash rate of 4.35 per cent was already having the intended effect of restraining demand, with the three increases delivered earlier this year flowing through to borrowing costs, mortgage payments and housing credit.

“At its meeting earlier this week (11 August), the Board judged that monetary policy is somewhat restrictive,” Mr Kent said.

“That’s important since, among other things, it underpins the forecasts for slow growth of aggregate demand, which is needed to reduce capacity pressures and bring inflation back to target.”

The comments confirm that the RBA believes its current policy setting is doing enough to slow the economy.

But Mr Kent was careful not to suggest that “somewhat restrictive” means monetary policy is sufficiently restrictive for the inflation battle to be considered won.

Instead, his speech highlighted just how uncertain that assessment has become.

“The evidence suggests that monetary policy in Australia is somewhat restrictive and that the tightening earlier this year is working (but) at the same time, several forces other than monetary policy are influencing financial conditions in Australia and so the stance of policy,” he said.

For property markets and homeowners, the outlook remains finely balanced.

Housing downturn adds to restrictive conditions

Mr Kent's assessment gives particular attention to housing, which he described as an important part of the transmission mechanism for monetary policy.

“Housing market conditions, including housing prices and growth in housing credit, also respond quickly to, and therefore can help inform our assessment of, financial conditions,” he said.

And the evidence is increasingly pointing towards a weaker market.

“Housing market conditions have softened noticeably in recent months,” Mr Kent said.

“Housing prices have declined in Sydney and Melbourne, with declines becoming increasingly broad-based.”

Growth in new housing loans has also fallen significantly, while auction clearance rates have dropped below their long-run averages.

The RBA’s latest assessment comes as national housing values have moved into decline, with the downturn spreading beyond the two largest capital cities. The central bank’s own data shows monthly national housing-price growth has been negative for four consecutive months, although Mr Kent noted that the current decline remains less severe than the downturns experienced in 2018–19 and 2022.

For the RBA, the important question is what the housing weakness tells it about the overall stance of monetary policy.

“Some of the downturn in the established housing market is what we would expect following the cash rate increases earlier this year,” Mr Kent said.

“Higher interest rates reduce the net present value of all assets, lower borrowing capacity, increase repayment burdens, and encourage saving.”

But he also identified forces beyond interest rates.

“Some of the downturn reflects a pull-back after a long period of very strong growth in housing prices,” he said.

Federal Budget tax changes affecting housing investors also appear to have reduced demand by lowering the after-tax return from property.

Mr Kent said this was significant for monetary policy because, all else equal, the changes “will tend to reduce the extent to which monetary policy needs to constrain the growth in aggregate demand” to return inflation to target.

Perhaps most importantly for borrowers, he said the housing market appears to have weakened by more than would normally be expected from the recent rate increases alone.

“While it is hard to be precise, the housing market appears to have softened by somewhat more than the recent increase in interest rates would imply, contributing to financial conditions potentially being a bit more restrictive than otherwise,” Mr Kent said.

That provides the clearest argument against another immediate rate rise.

Dr Callum Logan, Senior Lecturer in the School of Property, Construction and Project Management at RMIT University, said the latest rate decision could provide some relief for consumer confidence, but the spring selling season would provide a much better test of whether the recent improvement in auction results can be sustained.

“Clearance rates need to improve further to be reflective of a balanced market,” Mr Logan said.

He also noted that the slowdown, previously concentrated in Melbourne and Sydney, was now affecting all capital cities, while recent tax changes had reduced borrowing capacity for some investors.

“While there has been clearance rate improvement, the number of properties going to auction is less than this time last year for all capital cities. 

“Until recently, Perth, Brisbane and Adelaide markets were running hot while Melbourne and Sydney were stuck at a gas mark somewhere below simmer. However, the slowdown is now impacting all capital cities. 

“Recent tax changes for investors have reduced borrowing capacity as banks factor in the impact on mortgage serviceability, and the inability to secure finance for investment purchases within a self-managed super fund structure has closed off another pathway. 

“These are significant policy shifts occurring against a backdrop of higher inflation and global uncertainty. The blunt tool of monetary policy can deliver sharp hip‑pocket pain, and underlying inflation still exceeds the RBA’s two to three per cent target band.” 

For property investors and prospective buyers, this leaves a market in an awkward transition.

Matt Bell, Chief Economist at Oliver Hume Property Group, said financial markets had already largely anticipated Tuesday’s decision, with markets having priced in about a 96 per cent probability of a hold before the announcement.

He said markets were assigning just under a 50 per cent chance of another 25-basis-point increase by December, rising to slightly more than 50 per cent by March 2027, with cuts not expected until the second half of 2027 at the earliest.

That outlook is consistent with the cautious tone coming from the RBA.

Why rate cuts are still not a given

The complication is that financial conditions are broader than the cash rate.

Mr Kent said lending and deposit rates had increased in line with the cash rate, while scheduled mortgage payments had risen to close to their 2024 peak as a share of household disposable income.

Housing credit growth has slowed and new lending has declined.

At the same time, the Australian dollar has appreciated by around 5 per cent on a trade-weighted basis since the beginning of the year, another development that helps restrain inflation.

But not every measure is moving in the same direction.

“While financial conditions have tightened since the start of the year, some measures have eased over recent months,” Mr Kent said.

Market expectations for the cash rate have declined somewhat since May, reducing borrowing costs for some wholesale borrowers, while funding remains readily available and risk across many financial markets remains close to historical lows.

The RBA therefore believes the cash rate is around the top of the range of its estimates for the nominal neutral rate, the level that neither stimulates nor restrains economic activity.

But Mr Kent stressed that those estimates are uncertain.

That uncertainty is particularly important because several global forces could make Australian financial conditions less restrictive than the cash rate alone suggests.

The most unusual is the enormous investment currently flowing into artificial intelligence infrastructure.

“Substantial investment in data centres and AI-related infrastructure has helped to support growth in aggregate demand of late,” Mr Kent said.

“By itself, this AI activity means that policy rates need to be higher than otherwise, at least in the short run.”

Large government deficits and rising bond yields in major economies are another factor.

Mr Kent said rising government deficits had been cited as contributing to higher global neutral rates, which in turn “has reduced the tightness of Australian financial conditions for a given level of the cash rate”.

That leaves the RBA with competing forces, namely a domestic housing market that is clearly weakening and monetary policy that is already restrictive, against global demand and financial conditions that could prove more resilient than expected.

Mr Kent’s speech does not point towards an imminent rate cut. It does suggest the RBA is increasingly comfortable allowing the existing tightening to work through the economy before deciding whether further action is required.

“It takes some time for tighter monetary policy to have its full effect on economic activity and inflation,” he said.

The RBA clearly believes the medicine is working. The housing market is providing evidence that it is working quite strongly. But until the central bank is satisfied that inflation is returning sustainably to target, falling property prices alone will not be enough to produce a rapid shift towards lower interest rates.