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The Australian economy is continuing its 24-year expansionary run, the biggest risks being a global trade war and the indebtedness of Australian households. Domestic CPI inflation remains at 1.9%, below the Reserve Bank of Australia’s official target band of 2-3%; unemployment inched up to 5.6%. The RBA Shadow Board rules out any likelihood that a reduction in interest rates could be called for. Instead, it attaches a 52% probability that holding interest rates steady at 1.5% is the appropriate setting, while the confidence in a required rate hike increased further, to 48%. There is a clear shift in the Board’s assessment in favour of higher interest rates, which is also reflected in the six-month and 12-month recommendations.
The seasonally adjusted unemployment rate in Australia, according to the latest ABS figures, equals 5.6% in February. Employment growth has been strong (an increase of 17,500), especially full-time employment (an increase of 64,900), while the participation rate edged up to 65.7%. Low wages growth, remains the Achilles heel for Australian households. Nominal wages are growing at a mere 2.1%, about half the rate of ten years ago and well below the 20-year average of 3.3%.Without wages growth picking up significantly it is hard to see how household consumption will pick up and how households will be able to stabilize their overleveraged balance sheets.
The Aussie dollar, relative to the US dollar, has temporarily settled around 77 US¢. Yields on Australian 10-year government bonds have continued their recent gentle decline, to approximately 2.6%. This slide is somewhat surprising considering the more favourable outlook for the Australian economy; it may continue to reflect the uncertainty surrounding global asset markets or the damaging prospects of a global trade war initiated by the USA. The Australian stock market retreated further from its peak; the S&P/ASX 200 stock index currently stands at 5750 points.
The government’s difficulty in securing majorities in the Senate means that some uncertainty remains about the fiscal outlook and the federal budget next month. The budget deficit has remained in deficit since the GFC (currently at 1.9% of GDP) continues to be presented next month. Government debt is equal to approx. 40% of GDP and projected to rise further.
Global stock markets appear to have stabilized, at last momentarily, after their precipitous losses a couple of months ago. Volatility indexes remain elevated, so markets are expecting more gyrations in asset markets. Perhaps of greater concern for the world economy is the protectionist stance taken by the US and the retaliatory response by its trading partners. A full-out trade war would be a severe dampener to the global economic outlook, with the possibility of some nations experiencing a recession. This does not look likely for the Australian economy at this stage as trade negotiators are working hard to secure preferential treatment.
Business and consumer indicators have barely budged, with the exception of the manufacturing PMI, which jumped to 63.1 in March 2018 from 57.5 in February, posting the longest expansionary run since 2005. Capacity utilization, at 82.48% in February 2018, remains well above the 20-year average of 81. The Australian housing market still looks strong, especially the construction PMI (56 index points in February 2018, up from 54.3 in January) and clearance rates in the capital cities, but prices appear to be levelling out.
Since the last round in March 2018, the distribution of the Shadow Board’s policy preferences has strengthened further in favour of an interest rate increase. The Shadow Board is 52% confident that keeping interest rates on hold is the appropriate policy, 3% lower than one month ago. It attaches zero probability that a rate cut is appropriate (unchanged) and a 48% probability (45% in March) that a rate rise, to 1.75% or higher, is appropriate.
The probabilities at longer horizons are as follows: 6 months out, the estimated probability that the cash rate should remain at 1.50% equals 21%, two percentage points lower than in March. The estimated need for an interest rate decrease is 4% (unchanged from March), while the probability attached to a required increase equals 76% (74% in March). A year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 14% (15% in March), while the confidence in a required cash rate decrease equals 4% (3% in March), and in a required cash rate increase 82% (unchanged from March).
Despite the unpredictability in Donald policy, the case for leaving rates at historically low levels is now weak, and there seems little reason for the RBA not to raise rates in April. With global rates on the rise, the RBA should be looking to raise twice in the next three to six months unless the Donald takes further steps to trash the global economy.
While US interest rates are rising and the fiscal stimulus from the Trump Administration will add further to global interest rates this was factored into my assessment of the appropriate interest rate in Australia 6 and 12 months ahead. The extent of global interest rate changes as a results of US policy is as I previously expected but the uncertainty has narrowed because the policies are now in place. It is almost inevitable that Australia will follow the US rate increases. The uncertainty is around at what speed.
Real GDP showed persistent moderate growth in the final quarter of 2017, with exports and private investment still going backwards. The potential threat to global trade and prices from the tariff war started by the Trump administration is likely to impact negatively on the Australian economy, and may require postponing any plans for cash rate hikes in late 2018 and 2019.
Updated: 26 September 2021/Responsible Officer: Crawford Engagement/Page Contact: CAMA admin
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