- Financial markets and an increasing number of economists believe the RBA will cut Australia’s cash rate this year.
- An improvement in Australia’s budget position has also lead to speculation of additional or larger tax cuts in the April budget.
- Beyond those possible measures to support Australian economic growth, reforms to help lift productivity levels would also be helpful to the economy.
The global economy has become a more uncertain place in 2019 and this has central banks taking a dovish turn.
The Reserve Bank of Australia has now also fallen into this group, after Governor Phil Lowe switched the Bank’s long-held narrative from being adamant that the only way for rates is up, to now the risk to their future direction being “more evenly balanced”.
The Bank’s shift in outlook comes as the global environment softens and the domestic outlook muddies. Despite strong labour market performance, wages growth has yet to pick up materially and inflation has remained stubbornly below the Bank’s target. While the RBA has been patient in waiting for its objectives to be met, partial indicators have recently deteriorated, including recently the pace of GDP growth. And all the while home prices have been declining, a clear risk to spending from an already cautious consumer.
Consequently, financial markets and an increasing number of economists now agree the Australian economy has lost momentum and may lose further steam. If this does materialise, then a further relaxation of monetary policy may be required, and cuts in interest rates could be back on the RBA’s agenda. But in moving to this view, it’s worth questioning whether it is the appropriate course given Australia’s unsolved debt imbalances or, indeed, whether such action will be particularly effective in producing materially better economic outcomes at this point in the cycle.
While there’s no doubt the economy has been well supported by current monetary policy settings, in the new paradigm of stubbornly soft wages growth, it has not been sufficient to create conditions strong enough to allow the RBA to raise rates. While the Bank has argued that it is the level of rates that matter, and lower ones should be effective, it seems less consideration has been given to this course, which is not producing the desired outcome nor the imbalances it may exacerbate. Put simply if 325 basis points worth of policy rate cuts since November 2011 have not been enough for the RBA to achieve its objectives, will another 50 basis points — the measure of easing favoured by markets and economists — get it there? And if not, what policies either conventional or non-conventional will be deemed adequate?
Noting that such dramatic policy settings as zero/negative interest rates and quantitative easing are not without considerable risk, as the European and Japanese experience demonstrates. If we assume the RBA will eventually cut policy rates to 1%, then we should also consider how effective such a measure could be. It may assist at the margin, but it seems difficult to envisage it will support a material rejuvenation of the economy.
The reasons for this are many. Indeed, policy transmission itself is uncertain given funding pressures in short-term money markets – a 50 basis points move is unlikely to be passed on in full by lenders. For households, it is unlikely to have a material cash flow impact unless borrowers elect to change their arrangements. And while potentially stabilising housing prices, restrictions on credit, combined with buyer caution, are likely to still act in the other direction. Even if successful, attempting to go back to the well of household borrowing and debt to support the economy seems ill-advised.
It has not been too long since a key concern of the bank was financial stability and the magnitude of Australian household debt being among the highest in the world at around 120% of GDP. The matter of household confidence should also be considered, and the risk that the RBA cutting rates could lead to greater caution by households. Overall, it is unclear how monetary policy easing will bring about household income growth to support spending, inflation and the property market in a timely manner.
For businesses, further rate cuts are likely immaterial. Interest costs do not rank amongst their key concerns and it is doubtful a 50 basis point cut would move the needle on future investment and employment decisions. And what of the RBA’s natural stabiliser, the Australian dollar? It may move a few cents lower again, which will not achieve a lot. It may assist services exports but that will increases costs for importers making wages growth more difficult to achieve.
So what is to be done? Australia, unlike most other advanced economies, is in an enviable budgetary position and this could be constructively employed to assist the RBA in its efforts. Fiscal stimulus in the form of bringing forward household tax cuts, which are already planned by both sides of politics, might be a positive start but this is only a temporary solution. Further, it was clear in December’s national accounts, there is a lack of productivity growth weighing on the economy and wages growth – a problem monetary policy can not fix. What’s required, as most economists would assert, is productivity-enhancing labour market reforms.
This call comes from economists from all quarters, including those at the very top. RBA Governor Phil Lowe himself highlighted the importance of productivity to future prosperity in a speech last June. His assertion was that, based on the Productivity Commission’s list of priorities, reforms should target “the design of the tax system; the provision and pricing of infrastructure; the way we finance innovation and new businesses; and our business culture around innovation, risk and entrepreneurship”.
These measures, although clearly ambitious, would promote economic growth on a sustainable basis while also supporting living standards and real wage growth Australia is lacking.
Australia has for too long relied on monetary policy alone to support the economy, borrowing as much as we responsibly should from the future. It is time that policy-makers worked collectively to find a better way and government will need to play a greater role.
Alex Joiner is Chief Economist at IFM Investors.
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