By BOQ Chief Economist, Peter Munckton.
- The cash rate was kept unchanged at 1.50%;
- The RBA economy remains comfortable that the domestic economy is improving;
- But the global risks have risen a little in recent weeks;
- An extended period of an unchanged cash rate remains the most likely outcome.
Often I start my reports with a few lyrics from a song. The title of today’s report is a line that (surprisingly) I could not find in any lyrics. Maybe one day the line will end up being the start of a great song!
But the line also sums up what is currently facing the RBA. The global economy is doing well enough, albeit a little more mixed than what was served up in 2017. The US is powering ahead, with strong growth and inflation right where the US central bank (the Federal Reserve) would want it. The European economic data has been more mixed, although the European Central Bank (ECB) is confident enough to indicate they are winding down their QE (quantitative easing) program.
But concern about rising rates is impacting global financial markets. Countries as diverse as Argentina, Turkey and Italy have all suffered financial market wobbles over the past few weeks. The RBA noted today that in each case there were individual circumstances for investor concerns. But it is also true that in each of those countries there were some worries about the size of debt and the economic outlook, and this made them vulnerable to higher global interest rates.
While the RBA still appears comfortable with Chinese economic developments, there have been concerns expressed by other analysts. These worries have been a factor behind the decline in commodity prices (excepting energy commodities, such as oil and coal). It has also been a reason why the Chinese stockmarket has underperformed this year. The knock-on impact of Chinese economic worries has been felt on other currencies (such as the $A). Concerns about the Chinese economy have been discussed widely over recent years, most notably the substantial run-up of debt. The Chinese Government is aware of the economic risks and is supporting the economy (by allowing the exchange rate to depreciate, reducing interest rates, managing bad debts). The history of the past 20-30 years is that the Chinese Government has largely got managing the economy right. Nonetheless, whether the Chinese economy can remain on the straight and narrow will remain a key focus over the next few years.
One other concern noted by the RBA is the increasing tensions surrounding trade policy in the US. Financial markets have so far taken a relatively benign view of developments. But it is far from clear as to how developments will play out. The RBA also noted the rise that has taken place in short-term interest rates set by financial markets. They note that this rise has partly reflected technical development in the US market (although other factors also are playing a role). It is not clear as to how long these factors will remain.
Domestically, the RBA believes the economy is running in line with their forecast. The March quarter GDP numbers indicated that the economy was doing better than average, consistent with very strong levels of business sentiment. Partly this reflected the strong global economy. There is strong demand for iron ore, coal and gas. There are plenty of tourists coming to Australia, and there are plenty of overseas students attending Australian universities (and schools). Infrastructure spending is booming, most notably on the East Coast. Population growth is still relatively strong. Firms are again spending more on Capex.
The other bit of good news is that high business confidence has led to strong jobs growth over the past 1-2 years. A stronger labour market has significantly reduced consumer fears of unemployment. The RBA noted that job vacancy levels are high, and other indicators point to ongoing strong employment growth. More generally, consumers appreciate that the economic outlook is improving. But at the same time they indicate that the state of their own finances is only Ok, a reflection of the very modest growth in their disposable incomes over recent years.
Faced with a combination of subdued income growth but happy enough with how the wider economy is performing, consumers have made some changes to their spending and saving decisions. They are saving less in order to maintain their standard of living. If they have any spare cash they are more willing to pay down debt. This might be pleasing to regulators who worry about Australia’s high household debt ratio. But it also means that consumers are less likely to hit the shops for major household items (although retailers report that things might be improving, more particularly the larger shops).
Stronger growth in consumers’ disposable incomes will be needed to achieve sustainable strong economic growth. Higher consumer incomes will be a sign of a strong labour market. Higher consumer incomes will mean consumers are more likely to spend in the shops. Higher incomes will make it easier for households to pay down debt. And a bigger spending consumer will help small business, given that households are the key source of customer for the majority of smaller firms. The RBA thinks wages growth will rise, but it will take time.
The next big domestic economic number is the CPI data at the end of this month. Currently, inflation is a little under the RBA’s target. Consumers’ inflation expectations remain very low, although they have bottomed. Firms indicate that raising prices over the past year has become a little easier, albeit tougher than in the pre-GFC salad days. Price rises appear to be particularly hard to achieve in consumer-exposed sectors (such as retail and recreation), as well as industries facing tough global competition (such as manufacturing).
With inflation under the 2-3% target and the unemployment rate still around its 10-year average, the RBA is clearly not in any rush to hike rates. The next meeting will mark two years from the last rate change. And the period of inactivity will not end there. Economists agree, with the majority not projecting a rate hike until the second half of next year. And around one-third believe that there will be no rate change until at least the end of next year. This is more in line with financial market pricing with the first rate increase (at the time of writing) not priced until the first half of 2020. One bit of good news is that the $A is currently below most analysts’ forecasts (although there were made when the $A was trading above 75c).
So if the currency remains low, and investors are right that the cash rate will also be unchanged for some time, the Australian economy should continue to do well. But the global economic risks have risen.
The ex-Australian Prime Minister, Malcolm Fraser, was famously quoted as saying ‘Life wasn’t meant to be easy’. But in a play many years earlier, George Bernard Shaw wrote, ‘Life wasn’t meant to be easy my child; but take courage: it can be delightful.’ There is no doubt that the machinations globally are not making predictions about the economic outlook easy. But with a bit of luck the hope is that things will end up being delightful.
We live in interesting times.