Guessing what the Reserve Bank of Australia (RBA) might do next has become something of a national sport. As a nation, we’re more fascinated by central banks than ever before.
Up until the financial crisis in 2007, few people cared about central banks. But, as you’ll know, markets then crashed and interest rates plunged to never-before-seen levels across the world. It took a decade for this tide to begin turning. The UK and US have only recently seen their respective central banks raise rates.
Australia, on the other hand, didn’t witness rates drop to lows seen in the US, UK and elsewhere. The RBA swiftly lowered rates from 7.25% to 3% at the start of the panic. But other economies didn’t have an ace up their sleeve like Australia. China’s reliance on Australian commodities saw the economy rebound quickly from the downturn. As a sign of economic strength, the RBA reversed course. By October 2009, the RBA jacked up the cash rate seven times to 4.75%.
But that proved fleeting.
Between 2009 and 2016, the RBA would lower interest rates 12 times. Today, the cash rate stands at a record low 1.50%.
In fact, it’s been eight years since we’ve seen a rate increase at all. Moreover, it’s been 15 months since the last rate change. As a result, every research firm, analyst and market expert is placing bets on when the next move will be. They may not agree on the timing. But most agree on the direction — up.
Take the Organisation for Economic Co-operation and Development (OECD) for example. At the end of 2016, the OECD believed the RBA would start raising rates by the end of this year. Consultancy firm Deloitte also suggested the RBA would tighten monetary policy by early 2018. What’s more, both Australia and New Zealand Banking Group [ASX:ANZ] and National Australia Bank Ltd [ASX:NAB] predicted in September the RBA would raise the cash rate twice next year.
From my perspective, I suggested last year that there was no chance of a rate hike in 2017. I did, however, predict a rate cut this year. But strong iron ore prices at the back end of 2016 put an end to that idea.
So, where are things likely to go from here?
The interest rate outlook in 2018
In a bold move this week, Guy Debelle, the deputy governor of the RBA, inadvertently told the market what to expect. He believes there’ll be no rate rise in 2018.
Giving a speech in Sydney on Monday, Debelle said the Aussie economy was transitioning away from the mining sector. He says that non-mining investment is showing promise.
The following chart from the RBA appears to back his claim:
Source: Reserve Bank of Australia
[Click to enlarge]
Debelle reckons this chart proves that Australia’s days of relying on selling rocks to China are coming to an end. As you can see, mining investment is down. Yet non-mining investment, represented by the yellow line, has flat-lined of late. That’s despite being 17% higher than a decade ago. In any case, as Debelle sees it, this suggests that non-mining investment is taking up the slack.
But there’s just one problem. Debelle’s speech differed somewhat from how it was reported in the media.
Judging by the headlines I saw on Tuesday, the mainstream has taken the ‘everything is rosy’ angle. The Age notes:
‘There are signs of life returning to investment outside the mining industry, says the Reserve Bank of Australia, which is hoping business “animal spirit” will sustain spending in the services sector as the resources boom comes to an end.’
Yet compare that with what Debelle actually said:
‘Mining investment was strong because expectations for future demand were high and there wasn’t that much uncertainty around that expectation.
‘We are now seeing signs of that dynamic changing around the world and in Australia. With any luck, it will be sustained. This will be timely for the Australian economy as the mining investment story draws to its close.’
Debelle does point out that local business conditions are changing. But he also adds that this would be ‘timely’ for the Aussie market. And that this could happen with a bit of ‘luck’. In my view, he may as well be saying: ‘Dunno what’s going to happen…’
But it was after the speech, in an interview with Bloomberg, that markets found out what the RBA won’t being doing next. Playing up non-mining investment growth is one thing. But Debelle makes it clear that there’s one pocket of the market too sensitive to any changes:
‘Are we just going to jack up rates to see how the household sector lives with that? I don’t think so. If rates were materially higher, then the household sector would have trouble servicing their mortgages — we know that — and you have to think about what the environment is that rates are going to be going up in, it’s going to be an environment where the economy is stronger.’
And there you have it.
The overleveraged household sector is holding the RBA back. The RBA can talk about business activity all it wants. Yet, at the end of the day, it all comes down to how Australian households would cope with a rate increase. One that banks would almost certainly pass on to mortgagees.
In effect, the RBA has told us what to expect. It seems likely that we won’t see a rate increase next year.
Editor, Markets & Money