The RBA Just Lost Its Poker Game

Interest Rate Crash
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The Reserve Bank (RBA) has placed faith in strong employment and consumer spending to prop up the economy over the coming year. Despite slowing income growth, the RBA expects a robust jobs market to drive a consumer led rebound. But in placing an emphasis on consumer spending, it may have revealed its true intentions early.

There’s a good reason to believe that interest rates are set to fall again. The RBA may not be saying that outright, but it’s giving markets that signal. How? Because any uptick in the jobs market will come on the back of business investment. And that won’t transpire without easier lending standards.

Reading into the RBA’s statement, we can make a few guesses as to where its policy goes next. At the least, the cash rate should drop to 1.75%. That could happen by December, or early next year at the latest. It’s more or less a foregone conclusion at this point. But rates could dip even below this level. Especially if the export sector continues to lag on the back of weak global growth.

If anything, it’s easy seeing rates falling to as low as 1.25% by the end of 2016. That would equate to roughly three rate cuts over the next 14 months. The bank’s outlook is nothing if not optimistic. The RBA has set a bullish growth target of 3% in 2016.

We’re going to need multiple rate hikes to have any hope of meeting that. Achieving this ambitious target will require a stronger jobs market. That would help boost consumer spending in turn. The RBA clearly feels there’s a good chance of that, noting:

Growth appears to have picked up in the September quarter as resource exports and dwelling investment returned to growth following temporary weakness in the June quarter’.

But households will have to dip into their savings to lift spending. Which is a stretch considering the RBA even admits that income growth will be weak:

Consumption growth is forecast to increase notwithstanding the expectation that income growth will be modest over the forecast period. Consumption [is] forecast to grow at a rate slightly above average for 2016’.

As arguments go, it’s not a particularly convincing one. Which might explain why the RBA added that there is ‘considerable uncertainty’ over a rise in consumer spending. It reckons that the outcome will depend on whether households see this low wage growth as temporary or not. If so, then spending habits might rise. If not, then a deeper malaise could set in.

Yet all this might depend on house prices holding up in the future. Households will feel a lot better about things if house prices remain robust. Yet there’s no guarantee of that. Some analysts, like Macquarie and Morgan Stanley, forecast a bleak outlook for house prices. Morgan Stanley is particular bearish, predicting a 7.5% decline in prices starting next year.

What’s more, low wage growth is part and parcel of an improving jobs market. Weak income growth promotes hiring. So these forces are actually working against each other. Low wages help boost employment, but hinder consumer confidence.

Even if we overlook this fact, the unemployment rate will remain above 6% next year and beyond. The RBA expects a rise in the number of job seekers to keep unemployment high until well into 2017.

More than anything, this shows us the headspace the RBA currently occupies. Glenn Stevens, the RBA governor, yesterday suggested the bank had one choice going forward. It could either cut rates, or keep them steady. There is no alternative. Rate hikes aren’t an option.

You don’t come out with something like that unless you’re giving a rate cut serious thought. And you’re not talking about rate cuts if you’re truly optimistic about the future. For months, the RBA has indicated that it would set its policy according to economic conditions. It employed a wait and see attitude. But this is the first time it’s officially ruled out the possibility of a rate lift-off. In doing so, it’s raised prospects for more easing.

Yet we have to give the RBA credit for admitting as much. It’s the kind of concession that, in a way, suggests defeat. The RBA knows it has a real fight on its hands. It knows that rates will have to fall much further to keep the economy on even keel. Combating weak economic growth is a difficult task in a low growth global environment. The only question is how low they’ll end up going.

One way or another, the RBA wouldn’t make for good poker players. Ultimately, that might just be what markets wanted, and needed. Let’s just hope that optimism translates into higher consumer spending.

Mat Spasic,

Contributor, The Daily Reckoning

PS: None of this news comes as any surprise to The Daily Reckoning’s Phillip J. Anderson. Phil believes interest rates are set to remain low for decades…

Phil’s new report, ‘Why Interest Rates Could Stay Low for the 21st Century’, is a timely reminder of what the future holds. In the report, he warns that you won’t be able to count on your savings to fund your retirement. Inflation is only going to eat your reserves, as a result of record low interest rates.

But there are ways to benefit in this environment…provided you act now.

Phil will show you the best way to invest going forward. He’s prepared a four-step strategy to help boost your portfolio and wealth. You’ll learn exactly where to park your cash over the coming decades. To download the report, click here.

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