RBA 'Chilled' But Downside Risks Remain
The Reserve Bank of Australia has told us to “chill out” this Christmas and right on course it duly decided to leave interest rates on hold at its final meeting of the year. The RBA still retains what I’d describe as a modest easing bias, with the Governor suggesting if interest rates move anywhere anytime soon it will be more likely down than up.
So what the outlook for the economy and interest rates in 2016?
According to the latest Bloomberg Survey of 27 economists, the “median” expectation is for interest rates to remain on hold through all of 2016. Four economists think the RBA will raise interest rates next year, while 11 economists see interest rates falling. The rest are in the “no move” camp.
Interestingly among the major banks, ANZ Bank is the most aggressive, expecting the RBA to cut rates to 1.5% by mid-2016.
It just so happens that’s my view also. Earlier this year I has expected the RBA to cut rate to 1.5% by December – I was wrong. My view on economic growth and inflation were broadly correct – growth has remained below trend, and inflation is non-threatening in the lower half of the RA’s 2 to 3 per cent target band.
What I didn’t count on was the stubborn refusal of the unemployment rate to rise. Rather than rise through 6.5% as I expected, the unemployment rate dropped back to 5.9% in October. A blistering 311,000 jobs have been created over the past year if the surveys by the Australian Bureau of Statistics are to be believed.
While I still question the strength in the labour market number, but it is somewhat consistent with a list in corporate hiring intentions from several business surveys. It’s also consistent with the apparent shift in economic growth toward labour intensive service sectors such as health, education and hospitality – though these jobs do tend to be of the low wage and low productivity variety.
Also on the positive side is the National Australia Bank business survey. While choppy this year, overall the survey’s key measure of business conditions – perhaps surprisingly - has held at (slightly) above average levels in recent months. The rise to power of Malcolm Turnbull appears to have given corporate Australia a little more hope that adults are in charge in Canberra and pro-growth reforms could be forthcoming.
No doubt helping underpin growth in the economy this past year has been the housing sector, with solid gains in home building approvals. The September quarter national accounts released this week revealed that dwelling investment rose 0.9 per cent in the quarter to be up 10.3 per cent over the year. Although it does not account for a large direct share of the economy housing is special because of its large cyclical swings and extensive multiplier effects due to the input demands it sources from other sectors through the economy.
Household consumer spending also appears to have lifted a little in the past two quarters: it grew at a 2.8% annualised pace in the September quarter, and by 2.7% over the year. That’s not great, but arguably not that bad at a time when income growth remains weak. Helping support consumer spending has been a gentle decline in the saving rate to a (still reasonably high) 9% of disposable income, as well as (especially in Sydney and Melbourne) solid house price gains.
In terms of local demand and income, the biggest drags remain business investment. Mining investment remains is severe retreat and there still remains little sign of an offsetting upturn in non-mining investment. Indeed, the latest ABS capital expenditure survey confirmed that overall business investment should fall this financial year by a magnitude (at last 10% or so) not seen since the early 1990s recession. Public demand is also subdued thanks to continued efforts by Canberra to reign in its gaping budget deficit.
So where does this leave us?
Overall it’s hard to see economic growth picking up anytime soon. Business investment will remains weak and – my greatest fear – is that the widely under-appreciated contribution from home building to economic growth over the year will soon start to wane. And we’ve already seen the peak in Sydney home prices. That said, there does seem somewhat of a disconnect in the economy with business survey suggesting overall conditions are close to average and the unemployment rate, if anything, has broadly stabilised.
It will take a deterioration both business sentiment and/or the unemployment trend for the RBA to be goaded into cutting interest rates next year. I still see risks pointed downward rather than upward, and another risk in this regard will be the fate of global stocks markets as the Fed embarks on higher interest rates in coming months.
All up, times continue to favour a cautious view with regard to the equities market.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.