Although inflation remains well outside the Reserve Bank’s target range of two to three percent, the key indicators are pointing to a slowing economy and softening domestic demand, leading many experts to predict rates will remain stable and potentially fall during early 2009.
The Australian Bureau of Statistics recently released the June quarter Consumer Price Index (CPI) which revealed prices across Australia increased by 4.5 percent over the year ending June 2008; well outside the Reserve Bank’s target range of between 2 and 3 percent. Annual growth in the CPI hasn’t been this high since December 1995, apart from the spike caused by the introduction of GST in 2000.
Importantly, the underlying or ‘core’ rate of inflation, which excludes items such as fuel and fruit which have more volatile prices, was virtually flat during the June quarter. In fact, one of the RBA’s measures, the quarterly weighted median, actually fell during the quarter. Core inflation is the Reserve Bank’s preferred measure of price movements, and the minor fall during the June quarter may be an indication that past interest rate rises are starting to do their job.
The quarterly Consumer Price Index figures are important because they are one of the key indicators the Reserve Bank of Australia considers when assessing whether to change monetary policy. When CPI is above 3 percent the likelihood of an interest rate rise increases, particularly if the index is accelerating. Lifting rates is one of the primary tools the RBA uses to wind back consumer demand. Put simply, the higher interest rates go, the less consumers are inclined to spend, which in turn lowers demand driven pressure on price growth.
Recent statements from the Reserve Bank recognise that domestic demand is now slowing – a positive indication that Australian consumers are becoming more frugal and the economy is slowing. In fact, most if not all the key indicators are trending downwards: consumer and business sentiment are at 16 and 17 year lows, retail spending is flat, car sales are down, credit debt is winding back and housing finance commitments haven't been this low since 2004.
With core inflation now flat, together with evidence of a slowing economy and softer domestic demand, most economists seem to be aligned in the opinion that official interest rates have reached a peak. It is highly likely the next movement from the RBA is likely to be a rate cut – albeit probably not until early 2009.
With consumer confidence at 16 year lows and business confidence at 17 year lows the property market is experiencing a severe lack of buyer demand. Purchasing a property is one of the highest commitment purchase decisions most people will ever make. To make such a high commitment decision there simply needs to be a much higher level of confidence in the economy and market conditions. Volumes have dropped by more than 30% across most capital city markets as both home buyers and investors prefer to watch from the side lines. At the same time, stock levels in the market are above average as there are not enough buyers to soak up the stock.
The prospect of a stabilisation in interest rates is likely to be the key ingredient necessary to inject a degree of confidence back into the market. When the Reserve Bank next meets on August fifth the official cash rate will more than likely remain stable at 7.25% - the fifth consecutive month of stable rates. It is highly likely the Reserve Bank will begin to lower interest rates well before inflation falls below the 3 percent threshold (the RBA expects annual growth in CPI to remain above 3 percent until mid 2010). We expect that as rate cuts become more certain, consumer and business confidence will begin to improve which will have an immediate positive effect on property markets around the nation.