There’s been a distinct shift in mindset towards the outlook for Australian interest rates over the past month.
Gone are the days of rates being on hold for the foreseeable future, replaced by an growing chorus of views that the Reserve Bank of Australia (RBA) will begin to lift interest rates by the middle of next year.
Financial markets have certainly adopted that view, pricing in not only one rate hike, but maybe two, before the end of next year.
Economists at ANZ and the National Australia Bank have also tweaked their forecasts, joining the ranks of HSBC and TD Securities, among others, who see the cash rate moving higher before the middle of 2018.
Suddenly, almost by stealth, rate hikes are being seen as more likely than not next year.
However, while financial markets and an increasing number of economists think the RBA are about to hike rates for the first time since late 2010, Bill Evans, chief economist at Westpac, isn’t buying it.
Not only does he think that rates will be left unchanged at 1.5% next year, but in 2019 as well.
Far from seeing a rate hike within the next nine months, Evans says rates will remain on hold until at least 2020, suggesting that tepid economic growth, a lack of wage pressures, ongoing consumer caution and a slowdown in China’s economy will all act in tandem to keep the prospect of rate hikes at bay.
A key pillar of his call is that the Australian economy will not grow anywhere near as fast as the RBA thinks over the coming years, an outcome that will not be sufficient to generate wage or inflationary pressures in any meaningful way.
“The RBA expects growth in Australia to be 3.25% in 2018 and 3.5% in 2019. Westpac expects a below trend pace of 2.5% in both years,” he says.
Australia’s trend growth rate is widely perceived to be around 2.75% per annum.
So while the RBA is tipping that growth will accelerate to above-trend levels in the coming years, Evans says that growth will remain sub-trend, keeping inflationary pressures subdued.
“Going forward, the RBA’s inflation forecasts also look to be overly optimistic and are likely to be subject to downward revision,” he says, noting that revised weightings to the Australian Bureau of Statistics (ABS) CPI basket — introduced late this year — will likely reduce underlying inflation by 0.2-0.3% per annum.
The RBA is currently forecasting that underlying inflation will hit 2% per annum this year and next before accelerating to 2.5% in 2019. It currently sits at 1.8%.
Along with keeping a lid on inflationary pressures, Evans thinks that tepid economic growth will also weigh on wage growth in the period ahead, something he says will continue to hinder household spending.
Given the global lessons on the structural wages outlook, it seems unlikely that wages in Australia — where spare capacity is higher than in these other developed economies — will lift significantly even in the medium term,” he says.
Australia’s wage price index — measuring hourly wage rates — grew by 1.9% in the year to June, just off the record lows stuck in late 2016.
“This weak wages performance has lowered annual real income growth to 0.6% while real consumption growth has held around 2.5%,” Evans says.
“The shortfall has been funded by a falling savings rate, particularly in the highly stressed mining states.
“Overall Australia’s household savings rate has fallen from 9% to 4.6% over the last three years. Households will need to protect that fragile savings rate and pressures will emerge on consumer spending.”
In unison with a regulator-enforced slowdown in Australia’s housing market, something Evans says markets “may be underestimating”, he says there’s little need for interest rates to change for the foreseeable future, especially given uncertainty about the growth outlook for Australia’s largest trading partner, China.
“With Chairman Xi likely to cement power following the National Congress in October, we expect that he will have little choice but to adopt policies to gradually deal with the excessive build up in corporate debt in China, now 166% of GDP,” Evans says.
“Tighter credit conditions will slow China’s growth rate. We forecast a growth slowdown from 6.7% in 2017 to 6.2% in 2018.”
Given domestic and international considerations, Evans says that rates are likely remain at record lows should elevated risk aversion globally persist.
“Under our figuring, on the basis that this risk aversion persists for a few more years, a 40 month stretch of steady rates in Australia would not be out of place,” he says.