RBA to cut interest rates to 0.5%: Shane Oliver

RBA to cut interest rates to 0.5%: Shane Oliver
RBA to cut interest rates to 0.5%: Shane Oliver

EXPERT OBSERVATION

Australian GDP rose by 0.4% in the March quarter and annual growth slowed to 1.8%, which missed market forecasts of 0.5% and is also a little weaker than the RBA's recent forecasts. This was the weakest annual growth since September 2009.

The weakness in the Australian economy that started in mid-2018 has continued into early 2019 with the latest GDP data showing low economic growth in the March quarter (see chart below).

What’s more the make-up of growth in the March quarter remains concerning with falling private final demand for the second quarter in a row. Were it not for government spending and net exports GDP growth would have been zero.

We expect that this low growth environment will continue in Australia for now and we see GDP growth averaging around 1.75% over 2019, which is below RBA’s forecasts for growth around 2.75%.  

The economy is now in its 28th year of recession-free economic growth, and while the near-term outlook for growth still looks positive as the various parts of the economy muddle through, the outlook for 2020 looks challenging as government infrastructure spending looks like it will slow after this year, residential construction looks likely to continue to decline, the consumer is expected to remain weak and risks are building around the global economic outlook as a result of Trump’s trade wars. So we see a higher risk of an Australian recession in 2020 (risk of around 25% from 15% before).

More RBA interest rate cuts along with fiscal stimulus are likely to be necessary to offset the threat to growth. 

Click here to enlarge: 

RBA to cut interest rates to 0.5%: Shane Oliver

Source: ABS, AMP Capital

The key components of the data are:

  • Consumer spending rose by 0.3%, contributing 0.1 percentage points to March quarter GDP, and annual growth in spending declined to 1.8%. The household savings rate increased again, to 2.8% after bottoming at 2.5% in the September quarter. We expect that the fall in home prices and the associated negative wealth effect will push the household savings ratio higher over the next 1-2 years which will be a drag on consumer spending as wages growth is stuck at just over 2%. But consumer spending will benefit from the latest RBA interest rate cut (and further potential cuts) as well as tax stimulus, announced in the Federal Budget which will be paid after July when households do their tax return.
  • Housing investment continues to decline with residential construction down by 1.8% in the March quarter, alterations and additions spending falling by 3.8% and ownership transfer costs (a proxy for housing turnover activity) plummeting by 13.0% which all detracted 0.3 percentage points from growth. Building approvals for residential property have continued to fall so there is still further downside to residential construction. 
  • Underlying business investment (which takes into account asset transfers between the private and public sector) rose by 0.5% and contributed 0.1 percentage points to growth. Non-residential building activity is lifting after many quarters of weakness, engineering construction fell and machinery and equipment investment declined marginally. The outlook for non-mining investment is still looking okay, particularly for manufacturing, and mining investment looks like it is starting to lift again after falling since 2012 as commodity prices have held up well. 
  • Underlying government spending (which takes into account asset transfers between the private and public sector) rose by 0.7% and contributed 0.2 percentage points to growth. State and Federal government spending on infrastructure has been driving public spending over the past few years. While there are still many projects in the construction pipeline (particularly for transport), the pace of growth in public spending is declining and recent state government budgets indicate lower revenue (as stamp duty collections have fallen) and therefore some tightening in state fiscal spending which means that government spending growth will start to slow and in the absence of more infrastructure projects may become a drag on the economy later in 2020.
  • Inventories detracted 0.1 percentage points from growth as farm and public inventories collapsed (following a build up in the prior quarter) but private inventories increased.
  • Net exports contributed 0.2 percentage points to growth with a rise in export volumes and a fall in import volumes. Australia’s external sector is doing extremely well from the booming iron ore price (around $100USD/tonne) which is a boost to the government’s budget. But the risk is that the weakening global environment, particularly around trade, will hit net exports.
  • Inflation pressures and wages growth are still poor. Inflation as measured by the private final consumption deflator was just 0.4% in the March quarter or 1.5% over the year. Average compensation per employee was up by just 0.4% or 1.4% over the year which is well below the wage price data (of 2.3% year on year) reflecting compositional changes.
  • Productivity declined by 0.4% in the March quarter and is down by 0.9% which reconciles the divergence between strong employment growth and the weakening GDP numbers. 

Implications

With economic growth running well below potential, which is around 2.75%, the RBA will need to cut interest rates multiple times to get growth up and get the unemployment rate down below 4.5% (it is currently 5.2%) in order to get inflation back into its 2 to 3% target range.

We see another 0.25% rate cut in July or August and two more rate cuts in the first half of 2020 which will take the cash rate to 0.5% in 2020. Hopefully additional fiscal stimulus will help too. The need for quantitative easing is a rising risk, but hopefully it won’t be necessary.  

DR SHANE OLIVER is the Head of Investment Strategy and Chief Economist at AMP Capital.

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