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Monday, August 01, 2016

Housing no impediment as Reserve Bank prepares to cut

Apparent strong house price growth in Sydney and Melbourne is unlikely to dissuade the Reserve Bank from cutting interest rates on Tuesday, in part because it's not what it seems.

The CoreLogic home price index jumped 3.1 per cent in Sydney and 1.6 per cent in Melbourne after the Reserve Bank cut rates in May, and then a further 1.2 per cent and 0.8 per cent in June sparking fears that the Bank had ignited a new house price boom.

The jumps were inconsistent with other data showing that sales volumes and credit growth were weak.

Now Reserve Bank watchers believe they've cracked the puzzle. CoreLogic changed the way it calculated its indexes in May, adding to the apparent increases in cities whose prices had a history of rising quickly.

Until May it had removed extremely low and high prices from its index using bands defined in dollars. In May it switched to using bands defined by the top and bottom few percent of prices. Bank watchers believe the change pushed up the apparent price rises in Sydney and Melbourne, meaning the actual increases are less alarming.

If Tuesday's Reserve Bank board meeting believes this is so, it'll be left with few reasons not to cut its cash rate.

At just 1.7 and 1.3 per cent the Bank's trimmed mean and weighted index underlying measures of annual inflation are the lowest in records going back thirteen years. The headline rate is 1 per cent, well below the Bank's target of 2 to 3 per cent.

Employment is growing more slowly than new entrants to the labour force. Over the past six months employment has climbed 43,000 while the number of Australians looking for jobs has climbed 51,2000. A switch to part-time jobs means there were fewer hours worked in June than in January.

With neither inflation nor the labour market nor real estate prices an impediment, the Bank is likely to move its cash rate from 1.75 to 1.5 per cent on Tuesday, timing that will allow Governor Glenn Stevens to explain the reasons in the quarterly statement on monetary policy due out on Friday and in his final public speech to the Anika Foundation in Sydney the following Tuesday.

Governor Stevens retires on September 17 to be replaced by his deputy Philip Lowe, who is already a member of the board.

Tuesday's meeting will be the first for economic consultant Ian Harper, a former head of the Fair Pay Commission and chair of the government's competition review. He replaces a Labor appointee John Edwards who worked as an advisor to former prime minister Paul Keating.

Betting on the futures market assigns a 64 per cent probability to a cut on Tuesday, and a 100 per cent probability of a cut by November.

The Australian National University's so-called "shadow board" made up of nine market and academic economists including former Reserve Bank board member Warwick McKibbin believes the board should keep rates on hold, citing improved capacity utilisation, steady consumer and business confidence and slowly growing retail sales. It attaches an 18 per cent probability to a rate cut, up from 11 per cent last month.

Veteran RBA watcher Bill Evans said he thought the Bank was on track for a rate cut on Tuesday but that it would be a "close call".

"In my experience, when conditions are this close the better approach is to forecast what you see to be the best policy and that is another cut.," the Westpac chief economist said.

In The Age and Sydney Morning Herald