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Another rate cut on the horizon

David Bassanese
Wednesday, June 08, 2016

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By David Bassanese

Get set for a wild ride. New data emerging on the economy suggests it may be about to step up a gear, though perhaps not in the most balanced ways we might hope. That’s probably why the Reserve Bank baulked yesterday in signalling another interest rate cut is likely anytime soon. 

That said, I still think the RBA has another rate cut up its sleeve - but I’m a little less convinced than I was before yesterday. 

As we now all know, the Reserve Bank now seems hell bent on boosting wage and price inflation, given it's worried that wages growth is not much more than 2%, and it’s forecasting that underlying inflation will remain sub 2% until at least mid 2017. The longer inflation stays less than 2% the more likely inflation expectations will drop also, entrenching inflation at an uncomfortably low rate. 

Having cut interest rates in May, the RBA appeared to be readying itself to cut interest rates again in the months ahead. After all, the Bank usually doesn’t bother cutting interest rates if it felt the need to cut them only once. It usually has at least two in mind.

That said, in its Statement after yesterday’s June policy meeting, the RBA failed to explicitly reinstate a policy easing bias.  

That’s a departure from recent behaviour.

After having cut rates in February 2015, for example, the Bank left rates on hold in March but added to its Statement “further easing of policy may be appropriate over the period ahead, in order to foster sustainable growth in demand and inflation consistent with the target.” 

The RBA repeated this phrase after the April 2015 meeting, before cutting interest rates again in May. 

Note, moreover, the RBA also explicitly reinstated a similar easing bias in its June 2013 policy Statement - after it had cut rates a month earlier. It then cut rates again in August that year.

This time around, however, there was no explicit mention of a possible need to cut interest rates again.  

Why the reticence? For starters, the Australian dollar has dropped somewhat since the Bank last cut rates, and the US Federal Reserve (at least prior to last Friday’s shock payrolls report) did appear to be finally edging toward another rate hike either this month or July. So the RBA is probably a little less worried that the Australian dollar will stay uncomfortably high.

More importantly, however, the run of local economic data (as Peter likes to point out!) has been pretty upbeat. Business and consumer confidence have broadly lifted. Home building approvals kicked higher in April (albeit driven by lumpy high-rise construction) and appeared to have gained a second wind. The ANZ Job Advertisements Index also jumped 2.4% higher in May after appearing to flatten out in recent months. 

More broadly, the March quarter national accounts revealed that while business investment remains very weak (due to collapsing mining investment and pretty flat non-mining investment), other areas of the economy such as consumer spending, export volumes, public demand and housing construction are doing fairly well. Indeed, this was noted by the RBA in yesterday’s Statement, where it indicated that despite ongoing very large declines in business investment “other areas of domestic demand, as well as exports, have been expanding at a pace at or above trend.”

Of course, with inflation so low, the bar to another rate cut has been lowered. As I’ve previously argued, it’s no longer sufficient for the economy to be merely growing at a close to trend pace – as this would imply maintenance of excess capacity and current low wage and price inflation. 

The RBA appears to be aspiring for above-trend growth and a declining rate of unemployment. 

It’s for this reason I still think the RBA has at least one more rate cut to come, and most likely in August after another benign inflation reading in the June quarter CPI report due late next month. 

The only dark cloud to this outlook is the risk that low interest rates pose to some already overheated segments of the property market, and potentially share market valuations. The great hope is that low rates inspire better balanced economic growth through an overdue rebound in non-mining business investment, and lower share valuations through a timely lift in corporate earnings.

Published: Wednesday, June 08, 2016

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