RBA will be forced to cut interest rate to 1 percent or lower, Macquarie says

RBA will be forced to cut interest rate to 1 percent or lower, Macquarie says
RBA will be forced to cut interest rate to 1 percent or lower, Macquarie says

The official cash rate is likely to fall to 1 percent or lower as a lack of fiscal policy from the government places the onus on lifting demand on a weaker currency and the RBA, Macquarie says. 

In a bearish note, the investment bank's head of economic research James McIntyre says that without government policy support – backed by a global fiscal boost, or substantive structural reforms in key trading partners such as China – the RBA will be forced to cut rates further as it fights disinflatio n.

"With weak income growth a demand boost is needed. A weaker currency or fiscal policy boost are the two available options," Mr McIntyre said.

"The recent budget projected continued fiscal consolidation and only forecast a modest contribution to growth from public demand."

Wage growth hit an 18-year low in the March quarter, Australian Bureau of Statistics data showed this week.

Government support appears unlikely, and the currency is unlikely to fall on its own because global investors are drawn to the Australian dollar for its relatively high returns, given the ultra-low interest rates worldwide. 

The RBA will therefore be forced to slash the cash rate to 1 percent – a 75 basis-point fall from its current record low of 1.75 percent – or lower to keep a lid on the currency. It may have to cut even further to push the Aussie low enough to lift domestic demand, Mr McIntyre said. 

"The decline in the Australian dollar has helped to improve Australia's competitiveness whilst sustaining nominal price levels in the economy – although wages are adjusting lower," he said.

Bearish banks

But a further fall in the local currency to around US65¢ is necessary to assist the economy's adjustment beyond trade services, he said. The dollar is currently buying around US72¢.

The assessment is the most bearish among Australia's major banks. Commonwealth Bank of Australia, ANZ Banking Group and Westpac Banking Corporation all forecast a cut to 1.5 percent by the second quarter of 2017, according to a Bloomberg survey on May 6. But National Australia Bank has the rate remaining at 1.75 percent. 

Lower for longer interest rates would drive government bond yields lower, and Macquarie expects the 10-year bond yield to fall below 2 percent in the 2017 financial year.

On Monday the yield fell to 2.2 percent, its lowest level in more than a century, down from 2.55 percent ahead of the RBA's latest policy meeting, where the cash rate was cut to 1.75 percent.  

But the economy is still tipped to grow, and avoid a recession, Mr McIntyre said. 

Gross domestic product will grow at a rate of 2 to 2.5 percent, or "muddle through", helped by Australia's strong population growth and a one-off lift in resource export volumes that will generate 75 to 125 basis points of growth over the next three years. Outside of this boost, the economy will flatline. 

cash rate

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