When the governor of the Reserve Bank speaks, the market listens, trying to sift the gold dust out from the dirt for any signs of a movement in interest rates. And from Philip Lowe’s speech in Armidale on Tuesday, the market has very clearly sifted out a rate cut next week, as more evidence comes that fiscal and monetary policy are not working in the same direction.
The economy, as we all have a fair idea, is not performing as it should. Yes, employment is growing well – which is always a good thing – but overall GDP, productivity and inflation growth are all weak.
Wages growth remains equally slow, and given the recent increase in underutilisation, there is no sense of this changing anytime soon.
We have a government rather joyfully talking up a budget surplus for this financial year, which by definition is removing growth from the economy.
And so, what is left? Monetary policy – and it seems likely to be used again.
When Lowe suggested at the end of his speech that “the board is prepared to ease monetary policy further if needed to support sustainable growth in the economy, make further progress towards full employment, and achieve the inflation target over time”, everyone in the market said: “Thanks for the nod and the wink, Philip”.
As it is, the market had already been pricing in a pretty decent chance (76%) of a rate cut on 1 October:
And as a general rule the RBA does not surprise the market by not cutting rates.
The market is slightly more optimistic about things than it was six weeks ago, when it was sure of a further cut to 0.5% by February next year. Now they only see that occurring by May.
The governor noted that there have been clear signs recently that the issue of flat real income growth is translating into our spending habits. He said the “persistent slow growth in household income has led many people to reassess how fast their incomes will increase in the future. As they have done this, they have also reassessed their spending, particularly on discretionary items”:
There has also been a sharp fall in the sales of houses – the drop in house prices has been halted somewhat but growth in the overall number of houses being sold is as low as it has been since the early 1990s.
As a result, he noted, “with fewer of us moving homes, spending on new furniture and household appliances has been quite soft”.
In effect, the rise in house price data is from a smaller than usual number of houses being sold – and thus perhaps tells us less about the housing market than we think. It is not so much a recovery as a niche improvement.
A look at housing credit growth shows that, even with the improvement in June and July, monthly growth remains very weak – and investors continue to leave the market:
But the bigger issue for the RBA is business investment. Lowe suggested that “we will all be better off if businesses have the confidence to expand, invest, innovate and hire people.”
The current annual growth of business credit is below 5% – a level associated with very weak economic conditions – and a place where we have been now for most of the past decade:
This is an issue not just of businesses unwilling to grasp the “animal spirits” but also banks being too wary of lending money to small businesses.
We also saw in the latest engineering construction figures that construction for the private and public sector fell once again in the June quarter:
It represents a sharp fall in the level of public infrastructure work being done over the past 12 months:
It all goes again to the lack of fiscal expansion in the economy, and leaving the bank to do the work to get the economy moving again.
But in a broader sense, the world economic situation is mostly forcing the bank’s hand.
If other central banks cut their rates (as the US Federal Reserve recently has done), then the RBA needs to respond or our exchange rate will rise and make out exports more expensive, and that will hit our economy.
Lowe also noted the unprecedented levels of economic uncertainty due to the US-China trade dispute (exaggerated by having an unpredictable loon in the White House) and Brexit:
This uncertainty puts a hold on investment worldwide and generally has a stalling effect on the world economy – something that does not benefit Australia.
And while Australia is suffering less from policy uncertainty than the rest of the world, our outlook is not brilliant.
The spread between the Australian government 10-year and two-year bond yields is as close as it has been since the GFC – the closer the two get, the more likely it is that an economic downturn will occur:
And while the governor noted that inflation expectations have improved, they still remain at rock-bottom levels:
All of which adds up to a situation where, with no sign of the government willing to step up to the plate, it is left to the RBA.
And so a rate cut is very much more likely than not. All our previous mention of record low interest rates will have to be rewritten as a new record is about to be set again.
• Greg Jericho writes on economics for Guardian Australia