There’s something everyone is forgetting when it comes to rate cuts
Last week we saw markets ratchet back their bets on rate cuts this year. A few months ago it was a sure thing. They might come as early as May and we might get three or four this calendar year.
Now we’re walking those forecasts back. It will be late in the year now… if at all!
The central idea here is that inflation is proving to be stickier than hoped. With the labour market holding up and unemployment remaining very low, services inflation isn’t coming down as quickly as we’d hoped.
America is giving us our cue here. America is ahead in the data cycle, and most people expect that the Aussie data will follow the direction of their American versions.
That’s mostly fair enough, but there are some important differences between the US and Australian economies, and these differences are why I still expect we’ll be getting rate cuts here in Australia before too long, and probably before we start seeing cuts in America.
And the big differences to note are in the household data, and particularly the consumption data.
First up, with wages failing to keep pace with inflation, and inflation running hot, real household disposable income per capita is collapsing in Australia. In the US, apart from the most recent quarter, it’s been rising since early 2022.
In large part, that’s driven by the change in debt-servicing ratios. Unlike America, where the majority of mortgage holders are on fixed rates, in Australia almost everyone is on variable rates, which means the pass-through on official interest rate hikes is much more vicious. Like, the chart is crazy.
And it’s not just about the level. It’s the pace of change that’s given consumer’s whiplash too. We’ve never seen such a massive lift in the service ratio in such a short time – and nowhere else in the world is experiencing anything like it (except maybe New Zealand).
And because we still have people switching over from the cheap fixed-rate mortgages they got during Covid, that means that the average mortgage rate in the market will keep drifting higher in the coming months, even though the cash rate won’t change. That’s shown in the purple line here.
That is, if the RBA does nothing, the Australian economy will still get another rate HIKE, just through this roll-over effect. This will come at a time when rates will want to be coming down.
Anyway, put all that together, and it’s no wonder that Aussie households are reining it in, and pulling back on consumption. Consumption has fallen for five quarters in a row now (Blue bars). Compare that in America, where you have had six consecutive quarters of growth (red bars).
That’s the big difference between the US and Australian economies. Aussie households are getting smashed.
And remember, household consumption accounts for about 60% of GDP. So where this goes, the rest of the economy follows.
And this is why the case for rate cuts is much more urgent than it is in America.
And it’s why I think Australia will lead the way into the next rate cutting cycle.
JG.
V says
Coming… but slowly.