While the latest GDP figures suggested the economy is humming along nicely, the reality on the ground suggests otherwise. For now the Reserve Bank is content to wait before further cutting rates, but the worsening outlook for the world economy suggests that whoever does end up in power once the counting has been done might not have the luxury of leaving all the heavy lifting up to the RBA.
The RBA’s statement on Tuesday talked of the international and domestic economies as it always does. It referred specifically to Brexit, noting that “any effects of the referendum outcome on global economic activity remain to be seen and, outside the effects on the UK economy itself, may be hard to discern”.
Of the non-result thus far of the Australian election, they made no mention at all.
This is not all that unexpected; the RBA generally keeps itself above the political fray.
It wasn’t always thus. Back in July 1996 the RBA governor’s statement announcing its decision to cut rates by 0.5% strode straight into the politics of the moment:
“Today’s action by the Reserve Bank in no way diminishes the urgency of the task confronting the government of reducing the budget deficit. As the bank has emphasised on many occasions, further progress in reducing the budget deficit is critical to both increasing national saving and delivering lower interest rates over the medium term.”
Such were the joys of being the governor of the RBA in a period where the whole “independent” aspect was still being grappled with.
Now such as statement would be seen less as a sign of independence as of the RBA overstepping its bounds.
Now the RBA comments only on the economic situation, and on this score it remains fairly upbeat.
It notes that housing prices have improved slightly in the past couple of months, and that while mining investment is falling, “other areas of domestic demand, as well as exports, have been expanding at a pace at or above trend.”
That’s a generous outlook, for while in the national accounts consumption growth was ok, it remains below the growth levels achieved in the past. Also, even if we exclude engineering construction – a majority of which comes from the mining sector – then domestic demand remains well below trend:
The latest retail trade data which was released on Tuesday as well also showed a weakening.
The annual growth of 3.3% is the slowest since September 2013 – but whereas back then the trajectory was upward, now it is decidedly downwards heading:
And while the RBA might be seeing things with a shade of rose colour, they are still hedging their bets.
The Governor’s statement ends by noting that “over the period ahead, further information should allow the board to refine its assessment of the outlook for growth and inflation and to make any adjustment to the stance of policy that may be appropriate”.
Given there is no expectation that the cash rate will be raised, any adjustment will be to cut the rates. And the market believes this will occur – with a full rate cut priced to happen by November and a better than 50:50 chance of another cut to 1.25% by the end of next year.
The bond markets as well are not suggesting anything all that good is on the horizon.
Since the election on Saturday the yield for Australian government 10 year bonds has fallen even further than the record lows it hit last week.
On Wednesday it reached 1.85%:
Given that the current cash rate is just 1.75%, that in effect means investors see very little chance for increases in the interest rate over the next few years.
It is also a symptom of the yields for government bonds around the world absolutely collapsing as investors take more and more pessimistic views of the world economy over the next few years.
The 10 year bond yield is now just a touch over 30 basis points higher than that for the 2 year bonds. As a general rule the closer those two yields are, the worse is the outlook for the economy:
And given both yields are inexorably following the rest of the world down closer to zero (if not into negative territory like many other nations), we have a combined very weak outlook for the economy and also record low interest rates.
It means the government for the next thee years – should it survive that long – will have a situation where growth is expected to weaken but where interest rates will have little ability to do anything.
We know this ability is limited because pretty much every other nation that has cut its rates and indulged in quantitative easing (buying up of government bonds in an effort to increase the money supply in the economy) has at best stayed out of recession, but not experienced any great burst of economic growth.
Coupled with this is the fact that the interest rates the government has to pay are absolutely rock bottom.
Yesterday the government borrowed $700m for 12 years at the low, low rate of 2.0281%.
Investors are more than happy to borrow money from us, yet governments are worried about lending money for fear of losing our AAA credit rating.
And yet, what impact would that be?
Certainly the fear is it will cause the cost of borrowing to increase because notionally (if not in any real world sense) we would be considered more risky. But the general consensus is over the long-term it might add 10 to 20 basis points to the government’s bond yields.
For some perspective, the current 10 year bond yield of 1.85% is more than 100 basis points below the 2.87% on offer at the start of the year.
This doesn’t mean we need to go silly with our borrowing, but that there might be a unique opportunity where such is the overall strength of our economy relative to the rest of the world that we can be less mindful of the impact on our credit rating.
Interest rates are plummeting – regardless of nation’s credit ratings. While having a AAA credit rating is an advantage, we might be in an era where the advantage is less than it once was.
And if cutting interest rates won’t spur the economy, then maybe we should use these low rates to our advantage and borrow to do some nation building.
