Is the RBA about to drop a bombshell on us? A quick look at the back-story data shows us they’ve got every reason to cut if they want to…
I’ve been saying for a while that I expect one or two rate cuts this year, but there’s every chance we could see one this afternoon.
Really? It’s be a bit of a radical move, but Glenn’s not afraid of getting radical. And he’s got all the justification he needs.
First up, there’s inflation. Inflation is trending lower, and on the core measure (taking out volatile items), it’s just a fraction above the lower bound of the RBA’s target band of 2-3%.
They’ve got a country mile of head room. But this measure excludes petrol prices, which have dropped recently and driven inflation a lot lower. That won’t show up in the core measure straight away, but petrol is one of the fundamental building blocks of the economy. Lower prices, mean sooner or later, the price of most things will start to fall.
So that’s the inflation situation. We’ve only just got our head above the lower-bound, but there’s a heap of downward momentum coming our way. There’s enough of a story in this one chart alone to justify a rate cut tomorrow if they want to.
But what about the economy? How are we doing? Normally you only see rate cuts when the economy’s not going so great.
In my view though, the economy is holding up ok – well, even.
To start with petrol prices have given every thing a whip along. This has a big impact on the entire economy, because suddenly the cost of shipping stuff all over the place just got a whole lot cheaper. The physical side (less so for the services sector – real estate, finance etc….) of the economy just got a big shot in the arm.
But it has a huge and direct impact on consumers. The average weekly petrol bill has fallen to levels not seen since the aftermath of the GFC.
Household budgets just got a lot more wiggle room. We should see a bounce in consumer spending before too long.
Probably about 3 months if past form is anything to go by. This chart here tracks consumer sentiment and petrol prices (fast-forwarded by 3 months, and inverted.)
There’s a pretty tight relationship, and that makes sense because petrol makes up a considerable part of household budgets.
So we should see a boost in retail spending soon enough. But retail spending is already holding up well.
Towards the end of last year retail sales growth bounced up above averages of the past four years – where they were growing at just 2.7% a year, to around 6% pa. This is the kind of growth we saw in the boom years of the 2000s.
At the same time, record-low interest rates have reduced household debt servicing burdens.
Household debt as a percent of disposable income remains at record highs, but all that matters is whether households can afford those levels of debt. And one of the big reasons why they’ve been able to afford them up until now is because of falling interest rates.
Interest payments as a percent of disposable income have already been falling. Further rate cuts will drive them even lower.
This creates even more room in household budgets, and should also help give consumer spending a boost.
(This also, by the way, is a big boost for house price growth.)
At the same time, the production side of the economy is also doing pretty well – in part helped along by a lower Australian dollar.
The transition away from the mining boom has been one of the dominant themes over the past year or so. Would it be a gentle transition, or collapse and carnage?
Well now it seems that the gentle transition scenario is looking most likely. This chart here shows capex (capital expenditure = investment) in the mining and the non-mining sectors.
The downturn in mining investment is evident, but there is a clear upswing in the non-mining sector coming into play as well. And if we get more action on the consumer front, that should encourage even more investment.
It’s definitely not crash and carnage.
At the same time, our key export markets are going great guns. The US recovery is more solid every day, and China is also keeping it together.
A lot has been made of falling growth rates in China, but it’s mostly a statistical artefact. Big percentage growth rates are easier off a lower base. Even though growth rates are slowing, they’re still adding over a trillion USD to the economy every year.
That’s still big demand, and big demand for Australian commodities and exports.
So this is the picture that the RBA will be looking at. Inflation is stalling, but the economy is holding up well.
The RBA will be very happy with the recent falls against the USD, but you just can’t keep a good currency down – especially when other countries are tyring to drive their currencies down as well.
And Europe and Japan are throwing trillions at driving their currencies lower.
And if you look at what’s happened with the Aussie dollar, there’s been some good falls against the USD, but less so against many of the other major currencies. It’s even appreciated against the Canadian dollar and British Pound over the past month or so.
The RBA knows that in this environment, when everyone’s leaning hard on their currencies, you can’t just sit on the sidelines. You need to get in the game.
If they don’t move, and move soon, all the good work that’s happened could be undone.
So lower rates are coming. The only question is when…