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Interest rate path to determine if Aussie banks can sustain rich valuations in 2025

Published 12/26/2024, 05:33 PM
Updated 12/26/2024, 05:35 PM
© Reuters. FILE PHOTO: A view of the Commonwealth Bank building facade in the Sydney Central Business District, in Sydney, Australia, May 14, 2024. REUTERS/Jaimi Joy/File Photo
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By Himanshi Akhand and Shivangi Lahiri

(Reuters) - The Australian central bank's rate trajectory and its effect on inflation will decide if Australian bank shares can eke out growth in 2025 after a bumper year that has left valuations stretched, analysts said.

The financial sub-index, composed mainly of the country's biggest lenders, has risen almost 30% this year to mark its best yearly gain since 2009, outpacing an 8% gain in the S&P/ASX 200 benchmark index.

The sector's bumper performance was a result of inflows from superannuation funds and retail investors, who found comfort in the banks' ability to provide high capital returns in a weak economic environment.

Stable earnings performance and strong asset quality have pushed more funds into banks, while the impact of China's growth prospects on commodity prices saw a revaluation across the materials sector, multiple analysts said.

"Given the valuation stretch in the bank sector any fatigue in flow from what has been the dominant driver this year could be a trigger for multiple derate back to more normal valuation levels," Morgan Stanley (NYSE:MS) analysts said.

They added that their model portfolio positioning remains linked to a scenario that can see an ultimate rotation away from Australian banks and broaden into other sectors including resources.

The country's biggest lender Commonwealth Bank of Australia (OTC:CMWAY) jumped 39% and became the most valuable company on the local bourse.

CBA last traded at A$155.12 per share, much higher than the average 12-month price target of A$104.37, and has a forward price-to-earnings ratio of 27.55, according to data compiled by LSEG.

National Australia Bank (OTC:NABZY) rose nearly 22% this year, Westpac added 42% and ANZ logged a gain of about 11%.

The sustenance of this rally would ultimately depend on the Reserve Bank of Australia's (RBA) rate trajectory.

RBA has held interest rates at 4.35% for an entire year now, but opened the door to easing as early as February should data unfold as expected.

© Reuters. FILE PHOTO: A view of the Commonwealth Bank building facade in the Sydney Central Business District, in Sydney, Australia, May 14, 2024. REUTERS/Jaimi Joy/File Photo

Markets have since lifted the probability of a February easing to around 50%, while April is fully priced for a quarter-point cut.

If inflation remains elevated and short-term rates on hold, asset quality issues and slowing consumer spending may arise, but if rates are cut, investors may find other opportunities across the ASX as other companies may benefit from this inflation and rate relief, Citi analysts said.

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