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HSBC: Loose monetary policy is working but here's why the RBA will cut rates again

Photo by Ian MacNicol/Getty images

Australia’s remarkable economic run without a recession continued towards 25 years with 4th quarter 2015 GDP printing 0.6%.

That surprised many but it was the year on year growth rate of 3% which underscored just how incredible Australia’s growth is in a world beset with economic weakness.

That growth rate was “despite falling commodity prices and China’s slowdown”, Paul Bloxham, HSBC’s chief economist for Australia and New Zealand highlighted in a note to clients yesterday.

Bloxham said that it’s the RBA and the way it has handled monetary policy, both during the mining boom and since, which “deserves much of the credit”.

“Cuts to interest rates over the past four years and a significant fall in the AUD have been the key supports for growth. Low rates have lifted housing prices and construction, which is feeding through to a positive wealth effect on consumer spending. The lower AUD is supporting strong export growth, particularly of tourism and education services to Asia,” Bloxham wrote.

But Bloxham says there are still headwinds for the economy as it rebalances, meaning monetary policy still has a role to play. That’s because “although local growth has been solid in recent years, it has not been rapid enough to absorb all of the available spare capacity”.

He sets out four reasons why the RBA may need to ease again.

1. Low wages, low inflation. Unemployment has fallen to 6% but it is still well above the “full employment level of 5.25-5.5%”. That means wages growth is weak, “even the state with the strongest economic conditions, New South Wales,” Bloxham said. That has contributed to underlying inflation falling to the bottom of the RBA’s 2-3% band.

2. Mining investment will keep falling and oversupplied commodity markets persist. Bloxham highlights the unwind of the mining investment boom has further to run – the RBA has said consistently that this “drag” on economic growth will continue into 2017. Notwithstanding the recent rally in commodities from recent lows, Bloxham says “over-supply in many markets is set to keep them low”.

“Global growth is below trend and the Asian economies are being held back by weak global trade,” he added.

3. The housing boom is over. It was household consumption that really drove the strength of recent growth, contributing 0.4% of the 1.6% growth rate in the fourth quarter of 2015.

Bloxham says that is now at risk given the inevitable slowing in the housing boom. But he says “the end of the housing boom means it is unlikely that household consumption will continue at the same strong pace observed late last year”.

4. The rally in the Australian dollar threatens growth. The Aussie dollar has been a big part of the economic strength and transition. Its fall has helped facilitate the pick up in tourism and service exports. But that is at risk now with the Aussie up near 75 cents, not the 65 cents many had forecast, Bloxham says:

Low global inflation, further expected rate cuts from the ECB and Bank of Japan and the markets’ doubts about whether the US Federal Reserve will hike again this year, have meant that speculative positions have turned long on the Australian dollar. The currency has climbed from its low point of US69 cents in January to now trading around US74 cents. A higher Australian dollar is unhelpful for the rebalancing story and likely to put further downward pressure on already low underlying inflation.

This begs the question of will “there be enough growth to keep inflation on target?”

That’s doubly important because Australian financial conditions have tightened as the Aussie has rallied and as “effective mortgage and business lending rates have also been lifted in recent months, despite a steady RBA cash rate, as a result of regulatory changes and higher global funding costs,” Bloxham said.

So in the end, his call is that if the RBA wants to keep growth on track it will need to cut rates by 25 basis points, 0.25%, in the next few months.

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