Interest Rates Remain Unchanged…But Risks Are Rising

The Reserve Bank of Australia (RBA) left interest rates unchanged once again last week. Rates have stayed stuck at 1.5% for two years now.

The RBA also released its Statement of Monetary Policy last Friday. The 74-page document gives some interesting insights into the RBA’s current thinking.

And, as it showed, the Australian economy is a mixed bag.

As you can see in the graph below, the RBA expects GDP growth to increase at an average rate of 3.25% per year. That is until 2020, when it will ease to 3%.

They also expect the unemployment rate to decrease slowly from 5.5% to 5% by the end of 2020.

Graph of Output Growth and Inflation Forecasts

Source: RBA

[Click to open in a new window]

Yet, while they expect unemployment to decline, the bank doesn’t see inflation picking up anytime soon. In fact, they have reduced their forecast to 1.75% by the end of this year and are looking at inflation to reach 2.25% by 2020. That is the lower end of the RBA’s 2–3% target band.

With inflation staying put, ‘the Board does not see a strong case to adjust the cash rate in the near term.

Australians are looking at low interest rates for a while

The main culprit for low inflation is wage growth. While unemployment has been decreasing, wages have remained low. As the RBA noted:

Wages growth continues to be low and stable across most industries and states. Several factors have contributed to low wages growth including spare capacity in the labour market, and the process of adjustment to the end of the mining boom. Low wages growth has weighed on inflation because wages are the largest component of business costs. In turn, low inflation and expectations that inflation will remain low in the near term have weighed on wages growth.

In my opinion, one of the explanations for the low wage growth could be underemployment. That is, people that want to work more hours but can’t get them. As the RBA noted, most of the increase in employment this year was in part-time employment.

If controversial economist Phil Anderson is correct, interest rates could fall as low as 0%…but you could still turn a profit. Get your free action plan now.

Australia isn’t an isolated incident. While unemployment has decreased in most developed countries, wage growth hasn’t picked up.

The worry with wages not picking up is that it could affect household consumption. A large proportion of Australia’s growth comes from consumer spending.

With wage growth staying put, households have been increasingly taking on more debt. Savings have also dipped.

Now house prices are falling. As you can see in the graph below, household net wealth has decreased along with house price falls.

Graph of Household Net Wealth

Source: RBA

[Click to open in a new window]

And, while we have seen strong property prices in recent years, the fall in prices could very well affect household spending.

As the RBA noted (emphasis mine)

The high level of household debt also remains a key consideration for household consumption. For example, a highly indebted household facing weaker growth in disposable income or wealth than they had expected may respond by reducing consumption. Consumption growth may also be lower for a time if households concerned about their debt levels choose to pay down debt more quickly rather than consume out of additional income. […]

‘[H]ousing assets account for around 55 per cent of total household assets, so lower housing prices could lead to lower consumption growth than is currently forecast. Although the earlier gains in national housing wealth may not have encouraged much additional consumption, it is possible that the consumption decisions of highly indebted and/or credit-constrained households could be more sensitive to declines in housing prices than to the previous increases.’

The bank sees solid global economic growth and has a positive outlook, yet they also see some ‘important uncertainties,’ mainly coming from abroad. 

For one, protectionism in an increasing threat. As they noted:

While the outlook is largely unchanged from the May Statement on Monetary Policy, the downside risks to global growth from trade protectionism have increased. […]The risk is that an increase in protectionist measures could materially weaken the investment outlook and may weigh on confidence and financial market conditions more generally.

There is also the risk that the US sees stronger growth than expected. In the US, while the unemployment rate is at record lows, it has also benefited from a tax cut. Strong growth could mean higher inflation. Which could mean that the US Federal Reserve increases rates faster than expected.

As the RBA noted:

 ‘While the risks to global growth from trade protection policies have increased, there are also other important uncertainties. A continuation of solid growth and further absorption of spare capacity – particularly in some major advanced economies – could result in inflation picking up more quickly than is currently expected. This would have implications for monetary policies and financial markets.

And there are also concerns with China, Australia’s main trading partner.

As the bank wrote:

The risks to global growth from trade protectionism have increased. In light of this, and recent policy actions by Chinese authorities to manage financial risks and slowing growth, there is uncertainty about the outlook for China, which is a key trading partner for Australia.

The RBA has repeated that the next interest rate move will be up. Yet, as long as inflation stays low, there is not much reasoning for an increase.

If controversial economist Phil Anderson is correct, interest rates could fall as low as 0%…but you could still turn a profit. Get your free action plan now.

And, risks are mounting up.

Wage growth is barely increasing, property prices are falling and households have a lot of debt, which could slow consumption.

At the same time, there are concerns with increasing protectionism, inflation picking up in the US and a slowdown in China.

Unless inflation picks up, any deterioration could see the next interest rate move going down, not up.


Selva Freigedo,
Editor, Markets & Money

PS: Author and economist Harry Dent thinks the next economic upheaval is at our doorstep…and has a chilling warning for Australia in his new book Zero Hour. To find out more click here.

Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.

Leave a Reply

Your email address will not be published. Required fields are marked *

Markets & Money