Gloomy former RBA board member Bob Gregory predicts cash rate to fall to 1.5% but other bank economists more circumspect

The cash rate could fall as low as 1.5% because other sectors of the economy won’t pick up the slack from the declining mining sector, says former Reserve Bank board member professor Bob Gregory.

Gregory’s dark prediction is at the far end of the spectrum, the very far end in fact.

Bank economists reacting to today’s monetary policy statement put out by the Reserve Bank says it maintains an easing bias, but are circumspect on whether the cash rate will be cut much beyond one or two more times.

The Reserve Bank downgraded its economic forecasts today from a range of 2.25% - 3.25% to 2% - 3% with concerns about the pick-up in non-mining investment given the high Australian dollar and the labour market, though it did note a recover in dwelling investment and the housing market on the back of previous rate cuts.

Speaking at a recent economic conference, Gregory said interest rates could fall as low as 1.5% because the RBA will try to stimulate the economy to compensate for the end of the resources investment boom and a substantial decline in the prices of raw materials.

“Interest rates will fall. But I don’t think it’s going to work that much,” said Professor Gregory in comments reported on Wednesday by the Australian Financial Review.

Gregory’s conviction of a massive drop in the cash rate will be duly noted by many: aside from his former role as RBA board member from 1985 to 1990, he was also the first to diagnose the phenomenon of Dutch disease, where a mining boom drives up exchange rates and hurts the rest of the economy.

Along with the mining investment slide, Gregory predicts that real income in Australia could fall by 15% in the next few years with resulting lower living standards.

Commenting on the monetary policy statement, Westpac chief economist Bill Evans says the bank is encouraged that RBA governor Glenn Stevens “pointed out that there was scope to further cut rates should demand conditions require it”.

Evans points out that Stevens uses the word “scope” and “for the time being” in his comments on the cash rate.

“It is our experience that the use of [these terms] both indicate that the bank remains quite open to further easing policy.

Evans expects one further rate cut in the current easing cycle to take the cash rate to 2.75%.

ANZ’s head of Australian economics and property research, Ivan Colhoun, says the risks section of the report “details concerns the bank has about each of residential construction, mining investment, non-mining investment and public spending.

“These risks and the forecast for growth at or below trend over the next two years with low inflation suggests a strong bias to ease (as does the use of the term policy remained appropriate for the time being)”.

But, Colhoun says the RBA is still “clearly in assessment phase and will watch incoming data to decide whether the economy needs more stimulus.

“The continuing slow growth of employment and forecast rise in unemployment suggests clearly to us that the economy could afford to grow more quickly than at the present time and further gradual easing should be expected over 2013,” he says.

ANZ has moderated its forecast of a cash rate of 2% by year-end, but says there could be up to two rate cuts.

CommSec senior economist Savanth Sebastian says the RBA is "clearly in wait and see mode" after providing the domestic economy with 1.25 percentage point worth of rate cuts in a nine month period.
“Overall, the average interest rate on outstanding housing loans is now about 25 basis points above its 2009 low” … “The cumulative reduction in interest rates is affecting interest-sensitive parts of the economy, though the full effects will, of course, take more time to become apparent”.

Responding to the monetary policy statement, Sebastian says that while the Reserve Bank may have downgraded growth forecasts over the next year, “the accompanying commentary certainly suggests that board members are more comfortable than even just three months ago”.

“The risks to the ‘global economy appear to be more balanced’ while domestically the ‘significant monetary stimulus already in place, and signs of lower interest rates are having some of the expected effects’.

“In addition the Reserve Bank was at pains to point out that the average interest rate on outstanding housing loans is only ‘25 basis points above its 2009 low’,” he says.

CommSec expects the RBA to leave the cash rate on hold over the next couple of months though it “remains watchful”.

“There are few signs that the RBA is preparing to cut rates again in the short term, but arguably there are more events likely to result in lower rates than higher rates in the period ahead,” says Sebastian.

Commonwealth Bank economist John Peters says the monetary policy statement confirms the RBA’s “clear easing bias”.

“The financial markets have another two rate cuts priced in over the next few quarters, with the first next month.

“The capex data later this month is likely to confirm the RBA’s view that mining investment looks set to peak late this year.

“It may be sufficient to convince them, along with a benign fourth quarter (of 2012) wages report, that more insurance, via another rate cut, is required,” he says