Australia may need to readjust its GDP growth rate targets in the future. That’s the word coming from the Reserve Bank Governor Glenn Stevens. The RBA thinks slower population and wage growth will weigh on future growth rates.
There are other reasons growth rate expectations may need to fall. In addition to slowing migration, we’re getting older as a nation. There will be ever fewer taxpayers to pay for ballooning welfare spending.
And let’s not forget the resource sector. Mining revenues may never recover to match the heights of 2012.
All this begs the question: what is the ‘new normal’ for Australia? Well, it’ll certainly be lower than the 3–3.25% annual growth we’re accustomed to. Mr Stevens explains:
‘Perhaps trend output growth is lower than the 3% or 3.25% we have assumed for many years. That is, perhaps the growth we have seen is in fact closer to trend growth than we thought’.
This has been obvious for some time.
Interest rates have fallen by over 2% since 2012. These cuts coincided with the end of the mining boom. It doesn’t take a lot of foresight to predict the effect of the mining bust on potential growth rates.
At face value these warnings are three years too late. But it’s all part of a calculated play. The RBA knew this was coming the minute mining revenues began declining.
So why did Stevens feel the need to bring this up now? It’s simple really. The RBA is hesitant about lowering rates again. They’d never lower rates again if they didn’t have to. Their strategy now is to convince the markets to get used to lower GDP growth. That way they can put off making any decisions on interest rates.
Make no mistake; this is just part of the RBA’s public relations campaign. Mr Stevens talks about diminishing returns that accompany every new rate cut. Their impact on the economy is lessened with every change. He’s not wrong on that.
The effectiveness of the recent cuts leave a lot to be desired.
The RBA wants to pass on rate cuts to businesses, so they can start spending. Instead, all its doing is pushing up asset prices in property and stocks. Investors are satisfied, but it doesn’t help the broader economy.
Everything Mr Stevens says indicates the RBA will hold off on reducing interest rates. He even warned that rate cuts could set up a potential financial crisis in the future. Presumably he’s referring to the risk of rising inflation through credit expansion. Or the property and stock bubbles bursting in one fell swoop. Take your pick.
Because of this, the RBA will measure the benefits of cheaper loans against the long term risks. But is that really their game plan? I’m not convinced.
Is the RBA trying to jolt the markets into action?
Here’s another way to look at the RBA’s rhetoric. It’s possible they’re trying to spring a surprise on the markets. How? Easy. Convince everyone that they’re shy about lowering rates, and then hit them when they’re not looking. And why might they do this?
It’s because interest rate cuts are not only about lowering borrowing costs. They’re equally designed as a psychological tool to blunt the markets into spending. This instrument works best when consumers and businesses don’t expect it. If markets see it coming, apathy sets in, as it did with the last cut in May. Not only that, but the RBA’s monetary policy becomes predictable.
If businesses, or consumers, believe further rate cuts are coming, why would they spend now? They’d put off borrowing until loans are cheaper.
But Mr Stevens is doing a reasonable job of convincing the markets.
The unemployment rate is holding up. It’s been steady at 6% for the last year. The reasons for this are varied, but few of them bode well for the jobless rate. The stability is mostly down to slower population growth and low wage growth. It’s addition by subtraction, and it’s not a positive development for the economy. Mr Stevens explains:
‘If the slow growth of wages has in fact been a significant saver of jobs, that would appear to indicate a degree of labour market flexibility in operation’.
Mr Stevens also indicated that business confidence picked up over the past 12 months. That may be so. But he’s certainly aware that business spending is going to decline sharply in the coming year. The oft-quoted figure of $104 billion cut back in capital expenditure will burn a hole in the economy.
Reversing this kind of spending cut back will take a lot of work. The RBA is on record as saying that changing business spending will require fiscal policy, above all. Again, that’s their way of distancing themselves from another rate cut.
Businesses are showing that interest rates aren’t all that important in spending decisions. It’s the return on investments they care about. Interest rates won’t change that one way or another.
When is the next rate cut coming?
If we’re to believe the RBA is playing a game with the markets, then a rate cut could be around the corner. But let’s consider all the possibilities.
There are several schools of thought when it comes to forecasting rates in the next 12 months.
Mainstream economists recently penned a 90% chance of a rate by early next year.
Then there’s a niche segment that believes the RBA will only consider rate hikes, not cuts.
And there’s a third group, which predicts a rate cut as early as September this year.
The economy isn’t improving. It’s on a gradual decline. In that respect, the RBA is right. We’ll have to get used to a new normal as far as GDP growth is concerned. Not that this rules out rate cuts by any stretch of the imagination.
That’s why their recent rhetoric is revealing. It suggests that they’re readying the market for a rate cut over the coming months. There are two reasons for this.
One is that they’ll want to keep the value of the dollar down to help the flagging export industry. The other is that they still have room to cut rates further before the US starts to raise rates. Once the US does, and it should take place before late 2016, the RBA will have less pressure to keep rates low.
Contributor, The Daily Reckoning
PS: The Daily Reckoning’s Greg Canavan, one of Australia’s leading investment analysts, warns the economy is heading for a recession.
In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why GDP growth rates will fall below the RBA’s 3% forecasts. Even the RBA are now acknowledging as much.
Falling mining revenues, and higher trade deficits, are already taking their toll on the economy. Government revenues are down and household debt is up. Alongside slowing population and wage growth, these factors will continue the drag on the economy.
But there is hope for anyone who takes the effort to shield themselves from the recession. Greg will talk you through the steps you need to take to protect your portfolio and wealth. To find out how to download the report right now, click here.