Join a public policy conversation
Australia’s economy, in spite of its relatively low unemployment rate of 4.9%, is showing sign of weakness. CPI inflation, most recently equal to 1.8% in the December quarter, remains below the Reserve Bank of Australia’s official target band of 2-3%. Consumer and business confidence measures are softening, while house prices in the major capital cities are still retreating. The RBA Shadow Board’s conviction that the cash rate should be held constant next week barely budged while the bias towards a required increase in interest rates is lessening. More specifically, the Board attaches a 61% probability that holding interest rates steady at 1.5% is the appropriate setting, while the confidence in a required rate hike equals 33% and in a required rate cut equals 6%.
According to the ABS, the seasonally adjusted unemployment rate in Australia has fallen to 4.9% (February). However, total employment only increased by 4,600, and full-time employment actually fell by more than 7,000. The participation rate, accordingly, dropped slightly to 65.6%. There was no new data on wages growth. Its sustained weakness remains a concern.
The Aussie dollar (relative to the US dollar) has again tested, and found support at, 70 US¢, more recently trading around 71 US¢. Yields on Australian 10-year government bonds have accelerated their steady decline since November 2018, to a whisker above 1.7%. This means that the spread between long term yields and short term yields, has turned negative, as in the US. While in many countries, including the US, inverted yield curves are reliable harbingers of recessions, not so in Australia. However, they do point to future weakness in the Australian economy and typically signal RBA rate cuts. This happened in six out of the past seven yield curve inversions. The Australian share market, on the other hand, remains relatively buoyant, with the S&P/ASX 200 stock index consolidating around the 6,200 mark.
The outlook for the world economy appears to weaken. An inverted yield curve in the US has in the past 50 years always been followed by a significant contraction. It is therefore no surprise that the Federal Reserve has withdrawn from its intention to keep raising the federal funds rate in 2019, which in turn reduces the pressure for the RBA to lift rates. What strength exists in the global economy looks fragile, especially when considering the high private and public outstanding debt, the limited fiscal space and the low level of interest rates. The Trump administration’s fiscal boost is already fading and there remain doubts whether China can arrest the slowdown in its economy. Germany’s Ifo Business Climate Index increased slightly in March, after six successive declines, while the rest of Europe continues to post feeble growth. Emerging markets, likewise, are susceptible to shifts in financial market sentiment and to contractions in global trade flows. This fragility is underscored by political instability and geo-strategic tensions.
Consumer and business performance measures, on balance, are softening. The Westpac Melbourne Institute Consumer Sentiment Index fell from 104 to 98.8, whereas retail sales, month-on-month, remaining flat. The NAB business confidence index also fell, whereas the manufacturing PMI improved slightly and the AIG Performance of Services index remains at its lowest level in more than three years. Overall capacity utilisation in the economy fell noticeably, from 81.45% to 80.87.
The real estate sector’s decline is pausing. Even though house prices are continuing to fall in the major capital cities, building permits and the construction PMI have improved slightly. A further fall in house prices is widely expected and will most likely put a brake on consumption growth.
Assessing the fiscal outlook is difficult in the current climate, with the budget and federal election only weeks away.
As always, there is some disagreement among individual Shadow Board members. Collectively, the Shadow Board’s conviction that the overnight interest rate should be held constant is virtually unchanged. The Board is 61% confident that keeping interest rates on hold is the appropriate policy, down one percentage point from the previous month. It now attaches a 6% probability that a rate cut is appropriate (three percentage points higher than the previous month) and a 33% probability (35% 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% has fallen seven percentage points to 27%. The probability for an interest rate decrease has increased from 20% to 28%, whence it only equalled 11% in February, while the probability attached to a required increase has fallen further, to 44%. The numbers for the recommendations a year out paint a similar picture. The Shadow Board members’ confidence that the cash rate should be held steady fell eight percentage points, to 14%, while the confidence in a required cash rate decrease equals 28% (17% in March), and in a required cash rate increase 58% (61% in March). The width of the probability distributions over the 6 month and 12 month horizons remained unchanged, extending from 0.75 to 3.25.
Solid labour market outcomes suggest that the impact of weaker housing prices on the economy are not yet significant. International factors also remain relatively benign, and despite the Fed bowing to Donald Trumps demands to resist further rate normalisation the RBA should still be looking to raise rates in the medium term.
The likelihood of a significant slowdown in the economy in 2019 and 2020 has increased markedly, with the domestic and global symptoms increasingly evident. Financial markets in the US, Europe and Japan are now pricing in falls in government bond yields, and are even signalling a high probability of a federal funds rate cut by year end. Australia will almost surely have to follow these global interest rate declines. Australia’s exports are and will continue to be affected by the slowdown in the Chinese economy, caused by the tariff war and concerns about debt sustainability there. The Chinese government is implementing stimulus measures, but these will need time to succeed. In Australia, fragility in the household sector continues as a result of (excessive) property price downside risks and sluggish wages. In the looming Federal election, there is a notable risk that some policy promises being made might aggravate the contractionary phase. A technical recession will be avoided in Australia if monetary, fiscal and prudential policies are appropriately calibrated in timely anticipation. Cuts in the cash rate within the next 6 to 12 months are therefore recommended with high probability.
Updated: 26 September 2021/Responsible Officer: Crawford Engagement/Page Contact: CAMA admin
+61 2 6125 5111
The Australian National University, Canberra
CRICOS Provider : 00120C
ABN : 52 234 063 906