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.
How 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.
So what’s going to be the deciding factor?
The exchange rate. It comes back to that.
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…
Today?
Raman Venkatachalam says
Very true about growth rates. Higher growth rates at lower base economy is easier than at a higher level of economy. If China grew 10% 20 years ago, and grew 6% now, the now is better. What do you the readers think of investing in Australia? nothing is as safe as bricks or land. Returns on residential property is typically about 2.5% ex tax (in my opinion) and may be a bit higher for commercial properties. Stick it in a fixed deposit, you would earn say 3% ex tax. Can anyone shed some light on Govt treasury bonds yields? (historically and projected forward?)
Sowrabh Behl says
Good call Jon. Seems you were right on the Money
bazza says
I have thought for a long time our cash rate will go close to zero and was laughed at. Great call John on the rate cut and spot on as usual. I also expect another cut in the next two months as the RBA normally do.
Steve Christo says
Brilliant Jon.
Your logic (backed up with these charts) makes more sense to me than the scare mongering I witnessed over a year ago by a famous-for-some-reason american doomsdayer (I mean economist).
Stay healthy in mind and spirit and keep it coming straight down both barrels … please.
MarkS says
Great analysis Jon! Now watch for RBA to drop to 1.75% by the end of this year. Businesses need to be confident to invest and grow and create jobs and this will be the year the RBA makes sure business has a clear motivation and confidence.
Not Stupid says
Uhmm…. By the time you posted this EVERYONE was claiming there would be an interest rate drop. Hardly insightful analysis. To be insightful you needed to have made this claim about the middle of last year. It’s been obvious since then that a drop was coming, and clear since mid-Jan. that it would be in Feb.
ek says
well done Jon. Good prediction.
Ken says
When a certain Australian big bank offer lock in rates that are lower than the variable, hopefully you will know better than to do it. Not exactly rocket science. I’ve learned this from you and Dymphna, Jon.