In deciding to keep the cash rate at 1.5%, the Reserve Bank of Australia on Tuesday adopted a pretty positive outlook, which if it holds up would suggest the economy is in for some good times ahead. While there is evidence that 2017 should be better than 2016, the RBA appears to have decided that since cutting rates no longer has much impact, the best strategy is to be positive and hope for the best.
It’s always worth remembering where we are with interest rates. Keeping the cash rate at 1.5% means that the rate has been below 3% for 46 straight months. Prior to May 2013, the cash rate had never been below that level:
Where once such a low rate would be a signal that the economy was heading for a deep recession, it is now just viewed as a marginally accommodative rate that barely suggests any concern.
It’s a level that, to use the words of the RBA governor’s statement, is now just “consistent with sustainable growth in the economy and achieving the inflation target over time”.
Yet it is really a level that is so low there is much conjecture about whether any further cuts would have much impact. The law of diminishing returns is very much in place.
And so when cutting rates won’t do much good, the RBA might as well hope that things will improve, and the governor’s statement certainly did have a lot of optimism about it.
It noted that while the September GDP figures were poor (annual growth down to just 1.8%), it expects a pick up in the December quarter figures to be released on 1 March.
The RBA also continues to hold the view espoused in its most recent statement on monetary policy that economic growth will be around 3% over the next couple of years.
Now that’s a just a bit of an off-the-cuff kind of statement, but given what we have experienced over the past decade, it actually suggests things are about to get a lot better than they have been for a while.
Three per cent annual GDP growth used to be considered average – the level of growth required just to keep the unemployment rate steady. And on that score, the RBA estimating that GDP growth for the calendar year 2017 would be between 2.5% to 3.5%, and 3% to 4% in 2018 seems no big deal – after all, in 11 of the 15 years from 1993 to 2007, GDP growth was over 3%. But since 2007, only once – in 2012 – has GDP grown by more than 3% in a calendar year.
So when the RBA says that 2017 and 2018 should grow by around 3%, it is suggesting something that hasn’t happened since the global financial crisis.
The issue has been that we have one good quarter of solid growth, but rarely two or three in a row:
But the RBA is confident because it argues that “growth will be boosted by further increases in resource exports and by the period of declining mining investment coming to an end”.
Certainly exports look to be increasing – especially off the back of improved commodity prices – but that period of declining mining investment still looks to be ongoing.
The most recent estimate for mining investment for this financial year showed the strongest ever fall in expected investment:
So while the fall in investment might begin to slow, there haven’t been a lot of signs that we have reached the bottom yet. The first estimate of business investment for 2017-18 comes out in two weeks, and the RBA will be hoping the news is good.
The RBA also suggests that “consumption growth is expected to pick up from recent outcomes, but to remain moderate”. That again seems to be a pretty positive spin on the most recent figures, which suggest the annual growth in the volume of retail spending is at its lowest in five years. Clearly the RBA expects it to improve despite the weak December retail trade figures.
On this score as well, the RBA has put on the rose-coloured glasses with respect to confidence. It noted that “business and consumer confidence have both picked up”. Business confidence (as represented by the NAB business conditions index) is certainly better than during 2012-13, but it has been mostly steady over the past year, and if anything, is down a notch on the peaks reached in the middle of 2016:
Similarly, the ANZ-Roy Morgan consumer confidence measure has improved over the past month or so, but is only really back where it was around August to October last year:
And if anything, the Westpac-Melbourne Institute consumer sentiment index has fallen in the past couple months:
Certainly, the RBA’s own average of the two measures, released yesterday in the RBA’s chart pack, suggests a recent sharp drop in consumer confidence.
Despite the hoped-for improved economic growth, the RBA remains pretty much on the fence when it come to jobs. It notes that “labour market indicators continue to be mixed and there is considerable variation in employment outcomes across the country”.
It also noted that “the forward-looking indicators point to continued expansion in employment over the period ahead”. Here, there is perhaps a reason for those glasses to be rose-coloured. As I noted last month, the number of job vacancies continues to rise, even if the annual growth appears to have slowed a touch.
And in further good news, the latest issue of the department of employment’s leading indicator of employment measure is almost back in positive territory for the first time since the middle of 2015:
Regardless of whether its optimism is founded or not, the market certainly has taken the position that there will be no more interest rate cuts. In November, the market was forecasting the cash rate to stay at 1.5% for the next 18 months; now there is an almost 50% chance of a rate increase by the middle of next year:
But that rate rise will only occur if the RBA’s predictions come true. It’s worth remembering that two years ago the RBA was predicting GDP growth for the 2016 calendar year to be between 2.75% and 4.25%. Right now it’d be happy just to get the lowest of that range.
Here’s hoping the bank’s current positive outlook comes to fruition.
