The big picture
In the first half of 2008, anyone taking out a home loan in Australia would have been facing interest rates of over eight per cent. In fact, interest rates rose to around 9.6 per cent in mid 2008. It wouldn’t have mattered whether you locked in fixed rates or opted for a variable rate, interest rates were the highest in 12 years.
A year ago probably the best rate you could get on a home loan was the 12-month discounted variable rate of around 8.5 per cent. Personal loan rates were near 15 per cent with margin loans around 10.6 per cent.
Today, the standard variable home loan rate is around 5.6 per cent, down around four percentage points from the high. The discounted rate is at 4.6 per cent, personal loan rates are around 13.5 per cent and margin lending rates are around eight per cent.
With that in mind, it is hardly surprising that there has been frenetic refinancing activity by borrowers in recent months. Usually around $600 million of personal loans are usually refinanced each month. But in May, this total rose to $1.1 billion and then to $1.5 billion in June. Currently around half of personal lending is represented by either refinancing or consolidation of existing loans.
In terms of owner-occupied home loans, borrowers refinanced just over $4.2 billion of loans in both May and June, just shy of record highs. Given that interest rates hit their peaks a year ago, it is likely that refinancing will similarly hit new peaks over the next few months.
It is the magnitude of the rate reductions over the past year, together with signs that rates are set to move higher again, that has prompted the surge in refinancing activity. In short, the gains in spending power are too impressive to ignore. For a modest $100,000 25-year home loan, a rate reduction of two percentage points cuts $115 a month off repayments.
As the Reserve Bank has highlighted in the past, it is the actual level of interest rates that matters for the economy, not the monthly movements. The longer that rates stay low, the greater will be the number of people that will be able to take on new borrowings or reduce loan repayments. And there will be a further group that elect to pay higher instalments and cut the term of the loan, increasing equity.
Those observers that tip a slowdown in consumer spending in coming months simply haven’t been doing their homework. Real wage gains, tax cuts and generational low interest rates are providing an on-going boost to household disposable incomes. A two percentage point rate cut on the $830 billion stock of home loans unleashes $17 billion in spending power – one month’s worth of retail spending. The amount of stimulus in the economy far exceeds the two per cent drop in hours worked in the economy over the past year.
It’s hardly going to be raining economic data in Australia over the coming week. There are only two indicators of note, and even these don’t appear on the radar screens of some market economists. Again, it will be left to the Reserve Bank to provide the colour and light over the week.
The event that will generate the most interest is slated for Tuesday – namely the publication of minutes from the last Reserve Bank Board meeting. In line with recent speeches and statements from the Reserve Bank, the Board minutes are likely to be less upbeat about future prospects. Certainly the minutes will highlight the good readings published on the economy over the past month. But it is likely to give equal weight to the challenges, mainly emanating from the US and Europe.
On Wednesday, Malcolm Edey will deliver a speech looking at the impact of the global financial crisis on retail financial services in Australia. But analysts and investors are interested in just one topic – how soon will the rate hiking cycle commence?
On Thursday, the Reserve Bank will issue its monthly Bulletin. Most interest is in the latest credit card and debit card statistics. The indications are that the data will show another small fall in outstanding credit card debt. Household incomes have been boosted by rate cuts and government handouts, but many consumers have put it to work by cutting credit card debt.
The Bureau of Statistics will release imports data also on Thursday – figures that will provide insights on spending in the economy. And on the same day, data on household incomes will be released for the year to June 2008. While the estimates are a year old, they will provide new information on the shape of consumer balance sheets.
In the US, indicators on the housing market are centre stage in the coming week. Data on housing starts is released on Tuesday while existing home sales figures are issued on Friday. Housing starts have risen for the past two months while existing home sales have lifted for the past three months, so there are encouraging signs that the market has bottomed.
Of the other indicators, the influential Empire State survey is released on Monday together with capital flows data. On Tuesday, producer prices and housing starts are scheduled. The leading index is issued on Thursday together with the Philadelphia Fed index.
The leading index – as its name suggests – is designed to give some sense about where the economy is heading. The good news is that the leading index has risen for three straight months so there are high hopes that the economy will emulate the recovery seen over 2002 and 2003.
The profit reporting season cranks up a notch over the coming week. So far, there has been no particular theme but the use of the word “challenging” is particularly noticeable. Outlook statements have been cautious but there is a quiet confidence given that companies have weathered the storm over the past nine months.
On Monday, Ansell and BlueScope are expected to report earnings. On Tuesday, James Hardie, OneSteel and United Group are amongst those to report. It’s a big day for earnings on Wednesday with Amcor, Boral, CSL, Qantas and Woodside slated to report. AGL, AMP, ASX, Brambles, Rio Tinto, Santos are all listed to report on Thursday with IAG and Billabong on Friday.
The overnight indexed swap market is pricing the first rate hike to occur in the next six months. And in a year’s time the cash rate is expected to be near 3.75 per cent, up from three per cent currently. But interestingly, the implied yield on December 90-day bank bill futures stands at 3.89 per cent with June 2010 at five per cent.
CommSec currently expects the Reserve Bank to begin lifting rates in the March quarter of 2010. But if the good news continues for the Australian economy, policymakers will be increasingly nervous about leaving rates at generational lows. The cash rate stands at three per cent, but a “normal” cash rate is considered to be 5.25 per cent – admittedly for a “normal” economy. Borrowers shouldn’t wait until the writing is on the wall but prepare now for the rate hiking cycle.
It is always interesting watching analysts and journalists try to make sense of short-term movements in markets. Sometimes there is no rhyme or reason for the changes apart from the fact that markets have recorded solid gains and investors decide to take profits. That’s what happened over the past week.
Clearly when base metal prices rally 80 per cent in five months, investors will be looking to take some money off the table. Similarly, the Aussie dollar has rallied by 33 per cent over the past five months. At some point it needed to pause for breath. We continue to forecast the Aussie at US84 cents by end year and US89 cents by June 2010. None of the key drivers – especially the Chinese economic recovery – have changed. The real risk is that the Aussie exceeds these targets. The world sees Australia as a key beneficiary from China’s industrialisation.
Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
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