The cash rate has until now been unchanged in 2012 and the decision yesterday marks the biggest cut since the global financial crisis in February 2009. Although economists widely agreed that interest rates would be decreased this month, the 50 basis point cut was double the expectation. This could account for the fact that perhaps the RBA doesn’t expect lenders to pass the cut on in full. In fact, only about 40 basis points of the 50 basis points that have been cut since November 2011 have been passed on to home loan customers by the big four banks.

For a typical 25 year, $300,000 home loan, homeowners could save about $96 a month if the cut is passed on in full. This is a huge relief for home owners struggling in the current climate. We now wait to hear from the banks to see whether they will pass on all or part of the savings.

An indication of inflation, the Producer Price Indicator (PPI) was today revealed to have slid in the first quarter of 2012. The 0.3% fall in wholesale prices has reinforced the expectations of already convinced economists that the next rate announcement will be to lower the cash rate by 25 or even 50 base points.

The real indicator will be the closely watched Consumer Price Index (CPI) due tomorrow.

Since the Board last met, concerns about sovereign creditworthiness in several European countries have been a focus of financial markets. Investors have generally displayed a good deal more caution. As a result, equity prices have fallen and long-term government bond rates have declined outside of the countries most affected by the sovereign concerns. The Australian dollar fell sharply as part of this adjustment. Commodity prices have also softened, though those important for Australia remain at very high levels.

European policymakers have responded by assembling a large package to provide financing for the relevant countries for a period of time, stabilise bond markets and provide liquidity. They have also committed to action to bring budget deficits down and stabilise debt over time.

The effects of these various factors on the world economy will need to remain under review. At this stage, global growth is still expected to be at about trend pace in 2010. Conditions in Europe overall have been relatively weak, and the foreshadowed budgetary tightening will probably mean that this will continue, but growth is becoming more established in North America. In Asia, growth has continued to be quite strong and may need to moderate in the year ahead.

In Australia, with the high level of the terms of trade expected to add to incomes and demand, output growth over the year ahead is likely to be about trend, even though the effects of earlier expansionary policy measures will be diminishing. Inflation appears likely to be in the upper half of the target zone over the next year.

Consistent with that outlook, and as a result of actions at previous meetings, interest rates to borrowers are around their average levels of the past decade, which is a significant adjustment from the very expansionary settings reached a year ago. Taking all the available information into account, the Board views this setting of monetary policy as appropriate for the near term.

Mortgage holders will be disappointed with the increase. After being told by the Reserve Bank Governor, Glenn Stevens, that rates were getting close to normal levels, borrowers would have been hoping the pace of rate rises had slowed. Today’s 25 basis point rise takes the official rate to 4.50 per cent.

It is the sixth increase since September and means mortgage holders are now paying about $300 a month extra for their mortgages than they were in the middle of last year, says Domain.com.au blogger and property author Carolyn Boyd.

“There were a lot of mixed signals this month that may have had mortgage holders thinking they were in for a break. While inflation last week came in higher than expected, consumers have been spending less at the shops.”

Until today’s decision, mortgage holders on variable interest rates were paying about 7 per cent to their lenders. The rates that borrowers pay to their financial institutions are expected to normalize at about 7.5 per cent to 7.75 per cent by year’s end. That could signal there are still one or two more rate rises to come before Christmas.

The increase will be of little surprise to mortgage holders, who have been bracing themselves for a higher interest bill after repeated warnings by the Reserve Bank Governor, Glenn Stevens, that rates are on their way up. Todays 25 basis point rise takes the official rate to 4.25 per cent.

“This is now the fifth increase since September and means average Australian mortgage holders are now paying about $250 a month extra for their mortgages than they were in the middle of last year,” says Domain.com.au blogger and property writer Carolyn Boyd. “The property market has been running hot and the Reserve Bank will be hoping that todays increase will take a little bit of that momentum away”

The rate has many more rises to go before it reaches the most recent peak of 7.25 per cent, which it hit two years ago, in March 2008.

Until todays decision, mortgage holders on variable interest rates were paying about 6.75 per cent to their banks. The rates that borrowers pay to their financial institutions are expected to normalize at about 7.5 per cent to 7.75 per cent by years end.

While the move came as a surprise to many, there was enough indifferent data in the past fortnight to provide reasons for a pause and the RBA has never been keen to hike for too many consectuive months. Indeed, their latest streak of three months was the longest in history.

“Global financial markets are functioning much better than they were a year ago,” RBA Governor Glenn Stevens noted, upon releasing the news. “Credit conditions nonetheless remain difficult in the major countries as banks continue to face loan losses associated with the period of economic weakness. Concerns regarding some sovereigns have increased.

“In Australia, economic conditions have been stronger than expected, after a mild downturn a year ago. The effects of the fiscal stimulus on consumer demand have now faded, but household finances are being supported by strong labour market outcomes and a recovery in net worth.”

Mr Stevens said that the unemployment rate had probably peaked while inflation was likely to “be consistent with the target in 2010?.

The Board saw significant strength in the housing sector but they drew caution from soft business lending data. The central bank warned, however, that the cash rate would still trend up in the coming months.

“With the risk of serious economic contraction in Australia having passed, the Board had moved at recent meetings to lessen the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker,” Mr Stevens noted. “Lenders have generally raised rates a little more than the cash rate over recent months and most loan rates have risen by close to a percentage point. Since information about the early impact of those changes is still limited, the Board judged it appropriate to hold a steady setting of monetary policy for the time being.

“Interest rates to most borrowers nonetheless remain lower than average. If economic conditions evolve broadly as expected, the Board considers it likely that monetary policy will, over time, need to be adjusted further in order to ensure that inflation remains consistent with the target over the medium term.”

Australian home values recorded a 0.3 per cent fall in the month of December as the seasonal effect of the summer slowdown combined with rising interest rates and fading first time buyers put a dampener on a very strong year for Australian residential real estate.

While capital growth across all homes in the December quarter was the weakest of the year, values were still up an impressive 2.1 per cent – according to the Rismark-RP Date index.

All capital cities recorded strong capital gains during 2009 with the most spectacular results seen in the Darwin and Melbourne markets where home values were up 16.6 per cent and 15.6 per cent, respectively.

The weakest market during the year was Adelaide with values rising 6.2 per cent. Residential property in Brisbane achieved a slightly better outcome with 7.3 per cent growth. Arguably one of the most interesting stories of 2009 has been the recovery of the Perth property market with values increasing by 7.1 per cent after cumulative losses of 7.9 per cent since September 2007.

According to Tim Lawless, rpdata.com’s head of research, the market drivers changed considerably over the year.

“The strongest gains were recorded early in the year with national home values up 3.1 per cent over the first quarter of ‘09. The market was being led by first home buyers and consequently the most affordable end of the market saw a 3.9 per cent lift in values,” he advised. “Over the second and third quarters it was upgraders in the middle and the top ends of the market that generated the strongest gains. The top 20 per cent of Australia’s most expensive postcodes increased in value by 9.5 per cent over the last three quarters of the year compared to 4.1 per cent growth in cheapest 20 per cent of postcodes.”

Christopher Joye, managing director of Rismark International, expects higher interest rates will ensure the market does not overheat.

“We are projecting that the housing market will cool as mortgage rates normalise back to 7-8% levels. This implies that capital growth rates will fall back to single digit levels consistent with expected change in the incomes of prospective buyers.”

“It pays to remember that the price of Australian homes is only around 4.1 times disposable household incomes, which has been unchanged since September 2003. This tells us that over the last six years Australian house price have very closely tracked changes in household incomes. Contrary to popular myth, Australia’s house price-to-income ratio is not unusually high, nor has it risen in recent times,” Mr Joye added.

Rental market
Rental markets around the country have failed to keep pace with the rapid growth in home values resulting in lower rental yields across every capital city. Nationally, rental rates are down about 2.5 per cent which has resulted in rental yields being eroded.

Units outperform houses
2009 saw Australian unit values increase by 13.5 per cent compared with house values up 10.4 per cent. The trend was the consistent across every capital city, with units returning a strong gain over the year.

“The higher gains in the unit market are a deviation from normal performances,” Mr Lawless advised. “Historically houses have tended to outperform units. The recent reversal in fortunes has occurred due to more buyers leaning towards units because they have a more affordable price tag and are often located in more strategic locations in relation to transport and amenity than many detached housing options.

“Other factors may also include changing housing preferences, particularly amongst baby boomers, and more highly targeted unit developments being delivered to the market.”

City by City

Sydney

It is often forgotten that between December 2003 and December 2006 Sydney home values fell by over 6 per cent. 2009 finally saw Sydney home values recover with the December ‘09 home value now 5.8 per cent higher than the previous Feb ‘04 peak. Rental yields in Sydney are slightly higher than the national average with houses returning a gross yield of 4.2 per cent and units returning 5.1 per cent. The median price of a Sydney house over the December quarter was $600,000 and the median price of a Sydney unit was $430,000.

Melbourne

Similar to Sydney, between the end of 2003 and end of 2005 Melbourne home values only rose by 2.8 per cent. The Melbourne market recovered much sooner than Sydney’s and home values recorded a strong surge in 2007 (up 21 per cent compared to a 7 per cent gain in Sydney). 2009 was another big year for the Melbourne market with house values rising a further 14.9 per cent and unit values up 18.0 per cent. With such strong capital gains and a relatively flat rental market Melbourne rental yields suffered. Houses are now providing a gross rental return of 3.7 per cent (the lowest in the nation) and units are returning 4.3 per cent (the second lowest in the nation after Perth). The median price of a Melbourne house over the December quarter was $499,000 and the median price of a Melbourne unit was $410,750.

Brisbane

The Brisbane market remained comparatively subdued during 2009 with values increasing by 7.3 per cent over the year. The comparatively weak performance can partly be attributed to the strong gains recorded in 2007 where Brisbane values gained 24.6 per cent over the year. Gross rental yields in Brisbane remain above the national average with houses returning 4.4 per cent and units returning 5.0 per cent. 2010 is likely to see Brisbane outperform the national average due to the fact it is in a later stage of the cycle, together with ongoing strong population growth and the benefit of several major infrastructure projects coming to fruition. The median house price in Brisbane is now $463,000 and the median unit price $383,600

REIV CEO Enzo Raimondo said that Melbourne’s was the largest increase in the median house price since the REIV started keeping quarterly records.

“In the December quarter of 2000 the median house price increased by 14.9 per cent and by 12.4 per cent in December quarter of 2007, compared to 15 per cent in the 2009 December quarter,” he remarked. “The combination of a better than expected economic conditions and strong population growth has resulted in an unprecedented level of pressure on housing costs in Melbourne.

“The city’s population is increasing by around 1,700 people per week and unfortunately housing construction has not responded as quickly as would be necessary to ease the pressure in the market.”

Volume is also on the rise, a sign that surging prices are based on strong demand not just weak supply.

“The level of confidence in the market is apparent from the number of homes being bought and sold; the REIV has recorded an increase of 22 per cent since the 2008 December quarter,” Mr Raimondo reported. “This is highlighted by the strong growth in the middle of the market. The largest increases in median prices have occurred for homes priced between $500,000 and $900,000.

“Burwood recorded the largest increase – 23.1 per cent – as the median increased from $658,000 to $810,000. It was followed by Ringwood, with a 16.2 per cent increase; Mount Evelyn, whose median increased by 16.1 per cent, and Brunswick, which now has a median of $724,250 after a 15.2 per cent increase.

“Prices paid for units and apartments have also increased substantially, with a 7.6 per cent increase in the median from $410,000 in the September quarter to $441,000 in this quarter.

“The suburbs with the largest increases in median price for units and apartments were East Melbourne, followed by Port Melbourne, Armadale, Caulfield North and Northcote.”

House prices increased in key centres in regional Victoria as well. The median house price in the City of Ballarat increased by 7.3 per cent to $265,000; in Greater Bendigo by 4.3 per cent to $261,000; and in Greater Geelong by 4.4 per cent to $342,000.

Analyst Bill Morris told the AFR that his findings – which come from an analysis of figures from the Queensland Department of Natural Resources and Water – showed average Brisbane house prices reached $560, 000 in the six months to December 2009 – up $49,000 on six months earlier.

At the Gold Coast it was a similar story, with a surge of 7.6% to an average of $575,000.

Mr Morris believes the data shows a bottom has been reached, but cautioned that low volumes indicated tighter lending practices were still causing a problem for buyers.

The industry body remained cautious about the sustainability of the up-cycle, however, despite being confident that 2009/10 would be a healthier year for new residential construction.

“First home buyer-related activity, the Social Housing Initiative, and the lagged impact of very low mortgage rates will combine to generate growth in new residential work done in 2009/10,” HIA Chief Economist, Dr Harley Dale said. “It remains unclear, however, whether the recovery can gather legs beyond this year in the face of persistent supply side obstacles, rising interest rates, and what to date is an insufficient number of upgrade buyers and investors to fill the void left by first time buyers.”

Seasonally adjusted work done on new residential dwellings increased by 2.8 per cent in the September 2009 quarter to an annualised worth of $36.3 billion. This was 3.9 per cent down on the September 2008 quarter and over 9 per cent lower than the previous cyclical peak seen back in early 2004. Work done on detached houses increased by 6.5 per cent over the September 2009 quarter but work done on ‘other residential building’ dropped by 5.5 per cent.

Seasonally adjusted new residential work commenced in the September 2009 quarter increased by 5.8 per cent, the first rise since mid 2008.

The leading state for new residential work was Queensland, which reported a six per cent increase, while Victoria (3%) and NSW (2.8%) were also strong performers.