It was not exactly needed, but the latest cut in interest rates will provide a welcome boost to residential construction in Australia.

In its latest move, the Reserve Bank lowered the official cash rate by 25 basis points from 2.25 percent to 2.0 percent – Reserve Bank Governor Glen Stephens noting that notwithstanding easing global financing conditions, subdued levels of both public spending and private capital spending mean the economy is likely to be operating at ‘spare capacity’ for some time and that a further opportunity to boost household demand was in play notwithstanding concerns about rising house prices.

Whilst the precise impact of any singular rate cut is difficult to determine, especially given that the previous monetary policy stance was already extremely accommodative, common logic does suggest any reduction of the cost of borrowing provides a significant boost to both consumers’ capacity to finance the building of new homes and their willingness to do so, and that residential construction as an industry is therefore highly sensitive to monetary policy movements. Furthermore, the historic link between interest rate changes and new home builds is well established – a sustained drop in the cash rate of more than two basis points in total over the period spanning late 2011 to mid-2013, for example, was pretty closely followed by a very significant run up and sustained rise in new home approvals beginning in the early part of 2013.

Furthermore, recent data suggests that the already accommodative monetary stance has seen households – the ones who buy new houses – continue to spend despite a subdued economy (retail spending, for example, has been growing at respectable levels over recent months). This latest cut will help that.

Reserve Bank cash rate

That said, the biggest impact of the latest cut will most likely be felt in markets with more subdued economies such as Adelaide, Hobart and Brisbane, where consumers may need more persuasion to commit to new home purchases. Behaviour of less cautious investors and consumers in Sydney and Melbourne will probably be less impacted.

Of course, there is the fear that the latest cuts may pour fuel on an overheating market. Despite having come off peaks in recent months, investor borrowing to finance residential property purchases is running hot. Indeed, Stevens himself made strong note of this, saying that the RBA was ‘working with other regulators to assess and contain risks that may arise from the housing market’.

That said, such fears are mostly contained to Sydney, where price growth has been strongest of late and where the worst of the undersupply lies. Moreover, to the extent that easing of monetary policy helps stimulate new housing construction, this may help to boost levels of housing supply in the long run.

The latest decision is good news for construction. Now for governments to undertake the harder task of removing impediments to help the industry respond to the red hot demand conditions and long term issues of under-supply.