The move by the Reserve Bank to cut the cash rate to its record low of 0.75% is a clear indicator that the economy is struggling mightily and that the bank feels the government has completely abandoned its responsibility for triggering economic growth, leaving the RBA alone to try to get things going.
It is worth going back to the April budget this year when the treasurer, Josh Frydenberg, provided a nice little section titled “Strengthening the economy” in which he announced “the next stage in our economic plan to make Australia even stronger”.
“Even stronger” is an interesting phrasing given it suggested that the economy was actually strong. It wasn’t. GDP growth was falling to its worst levels since 2001 and the second worst for 27 years, unemployment was rising and GDP per capita was actually going backwards.
Then after 33 months of keeping the cash rate steady at 1.5% the Reserve Bank cut rates in June to 1.25%, to 1.0% in July and now another cut to 0.75%.
This is not something you see happening when the economy is “strengthening”.
Not only are we at the lowest cash rate, it is the lowest in real terms as well – at 0.75% the rate is is 0.85% pts below inflation growth of 1.6%:
It is not so much a case of the RBA putting the foot to the floor to get the economic engine revving, as it is putting its foot through the floor.
The government has been purposefully asleep while this has happened.
Consider that just after the budget the market was already anticipating a cut in interest rates. But back in April the market only thought the RBA might just cut to 1.25% and gave a slight chance of a cut to 1.0% happening some time next year.
We are now not only past that, the market is now anticipating a further cut to 0.5% by early next year and a nearly 50% chance of another cut to 0.25%:
While this has been happening the government has continued to suggest everything is going to plan. The treasurer sought to echo the words of the RBA governor saying “the domestic economy has reached a gentle turning point and they positively referred to the benefits that are flowing from the tax cuts”.
I guess you could say there has been this turning point – the first six months of this year saw slightly stronger growth than the last six months of 2018. But even still, the growth from January to June this year was among the slowest we have experienced since the GFC – and GDP per capita was still falling:
There isn’t a great deal of evidence that things are improving. The latest building approval figures out this week showed that for the 17th month straight the number of approvals for private sector houses fell:
The low interest rates might be seeing a bit of a spike in house prices, but they are not creating much real economic activity yet.
The government will be desperately hoping the August retail trade figures out tomorrow show some sign of improvement, because if not the hope for a lift in household consumption in the September GDP figures will be quickly slipping away.
And that is why the RBA has seen the need to cut even further – because it not only wants to get GDP growth improving, it also is desperate to see inflation and wages growth improve because that will see people spending again in the shops.
The only way this can happen is if the level of spare capacity in the labour market falls.
And that means a fall in both unemployment and underemployment.
It is here we saw the biggest change in the RBA’s outlook.
As noted by the economist Jason Murphy, the governor’s statement announcing the rate cut on Tuesday included a change in wording from September’s line of saying the aim was to “make progress in reducing unemployment”. On Tuesday the aim became “to reach full employment”.
What is full employment? It is not when everyone has a job – it is when the unemployment rate is such that if it falls any lower inflation growth starts accelerating.
The last time this happened was in 2007-08 at the end of the mining boom when the unemployment rate reached 4.2%:
Given the current unemployment rate is 5.3% that suggests we have a long way to go – the equivalent of about 140,000 people currently unemployed getting a job.
But back in 2007-08 when unemployment fell to that low level, the underemployment rate was about 6%. It is now 8.5%.
To get that back to 6% about 340,000 currently underemployed workers would need to become satisfied with the level of hours they are working.
Until both of these things happen we are unlikely to see inflation take off, because the key is getting underutilisation – the combination of unemployment and underemployment – down below 10.5% rather than the current rate of 13.7%:
So in effect this means we need nearly half a million people currently in the labour force to either get a job or get more work in order to reach a point of “full employment”.
That’s a big ask, especially when you take into account we also need to find work for people who will be entering the labour force.
And it demonstrates why investors believe there are more cuts to come. There is no way this will be achieved any time soon if the government continues to act as if all is going to plan. It means the RBA will have to cut rates further and in effect enter a period where either we have a negative cash rate or quantitative easing occurs.
Either way we are seeing the economic equivalent of swimming with just one arm – you have to work twice as hard to stay afloat, and the longer you do it, the greater becomes your chances of drowning.
Greg Jericho writes on economics for Guardian Australia