Economic and Financial Market Update: It Aint Over Until It's Over
Summary:
• The RBA kept the cash rate unchanged at 0.75% at its November meeting;
• Their economic growth forecasts are broadly unchanged from August;
• The RBA remains worried about the downside risks;
• They maintain a clear bias to reduce rates further;
• It is clear that rates will remain low for an extended period.
‘It ain’t over until it’s over’
- Yogi Berra
This was one of the (many) famous quotes from the well-known US baseball manager, Yogi Berra. Politicians have used the phrase, so have TV characters and (of course) other sportsmen (and women). It was even the theme of a song by Lenny Kravitz. The phrase could also be applied to this interest rate cycle. The first rate cut took place in November 2011. Eight years later we are still waiting for our first rate hike. This is the longest cycle I could find since at least the mid-1970s (although at various times since 2011 Markets and economists expected rate hikes).
Why has this interest rate cycle been unusually long? Global events have been important. Research shows that it takes a long time to recover from a recession caused by too much debt. And the GFC (and the subsequent European debt crisis) was the biggest event (outside of major wars) to impact the world economy since the Great Depression in the 1930s.
An aging population has likely been another factor, reducing economic growth (and therefore incentives to invest). China helped carry the global economy post the GFC. But its economic growth is slowing as it attempts to ensure the growth path becomes more sustainable (less debt, less pollution, less inequality). Technological change is impacting particular industries (notably retail). The rise of political uncertainty is another factor (Brexit, Trade and Technology Wars, Middle East uncertainty). Domestically, the Australian economy has been (with some success) dealing with the end of the largest mining boom in history.
So a combination of global and domestic events have combined to make this a very long interest rate cycle. And in today’s Statement the RBA made it very clear that the risk is that interest rates could decline even further. Each quarter the RBA provides an update of its economic view. The latest updates don’t look too different from those provided in August (although the inflation projections look a touch lower). But it is the concern that growth and inflation might continue to disappoint means the risks are clearly tilted towards lower rates.
Below is a comparison of this month’s statement with last time it updated its view (August) with some comment.
Global economy
August
The outlook for the global economy remains reasonable. However, the increased uncertainty generated by the trade and technology disputes is affecting investment and means that the risks to the global economy remain tilted to the downside. In most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. The slowdown in global trade has contributed to slower growth in Asia. In China, the authorities have taken steps to support the economy, while continuing to address risks in the financial system.
November
While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The US–China trade and technology disputes continue to affect international trade flows and investment as businesses scale back spending plans because of the uncertainty. At the same time, in most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. In China, the authorities have taken steps to support the economy while continuing to address risks in the financial system.
Comment:
The global economy has been slowing over the past 18 months. Trade volumes have been down. The manufacturing sector is essentially in recession (notably the car industry). Unemployment rates are low in most countries allowing service sectors to have done better. The concern is that the slowing manufacturing and trade sectors impacts the strong service sectors.
The US has done best. Germany’s struggles are impacting Europe. China is slowing. Low interest rates are having only a minimal impact. The data over the past couple of months have been better than what financial markets had been pricing and is one reason why interest rates have risen. Sustained economic growth will likely require a bigger contribution from more Governments.
World Export Volumes
(% change over year, 3 month average)
World Uncertainty About Economic Policy
(world GDP weighted St Deb from normal, 6 month average)
Chinese Industrial Company Profits
(annual % chnage)
US Unemployment Rate
Financial Markets
August
Global financial conditions remain accommodative. The persistent downside risks to the global economy combined with subdued inflation have led a number of central banks to reduce interest rates this year and further monetary easing is widely expected. Long-term government bond yields have declined further and are at record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at its lowest level of recent times.
November
Interest rates are very low around the world and a number of central banks have eased monetary policy in response to the persistent downside risks and subdued inflation. Expectations of further monetary easing have generally been scaled back over the past month and financial market sentiment has improved a little. Even so, long-term government bond yields are around record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at the lower end of its range over recent times.
Comment:
There has been a general improvement of risk sentiment in financial markets over the past month. Equity markets have risen, as have interest rates. Credit spreads have narrowed. Falling interest rates in developed markets has enabled emerging markets to also reduce their rates. The $US has declined a little. The relatively greater reduction of interest rates in Australia has resulted in reduced foreign buying helping to weaken the Australian dollar. Financial markets remain vulnerable to either a slowdown of economic growth, a sharp rise of interest rates or an unexpected increase of inflation.
World Equity Markt Price Earning Ratio
US 2-10 Government Bond Yield Curve
Rest Of World Net Purchases Of Australian Financial Assets
(4 quarter sum, $m)
Australian Dollar
(trade-weighted index)
Australian Economy
August
Economic growth in Australia over the first half of this year has been lower than earlier expected, with household consumption weighed down by a protracted period of low income growth and declining housing prices. Looking forward, growth in Australia is expected to strengthen gradually from here. The central scenario is for the Australian economy to grow by around 2½ per cent over 2019 and 2¾ per cent over 2020. The outlook is being supported by the low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some housing markets and a brighter outlook for the resources sector. The main domestic uncertainty continues to be the outlook for consumption, although a pick-up in growth in household disposable income and a stabilisation of the housing market are expected to support spending.
November
The outlook for the Australian economy is little changed from three months ago. After a soft patch in the second half of last year, a gentle turning point appears to have been reached. The central scenario is for the Australian economy to grow by around 2¼ per cent this year and then for growth gradually to pick up to around 3 per cent in 2021. The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, the upswing in housing prices in some markets and a brighter outlook for the resources sector should all support growth. The main domestic uncertainty continues to be the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending. Other sources of uncertainty include the effects of the drought and the evolution of the housing construction cycle.
Comment:
The Australian economy continued to slow over the course of the second half of 2019. Both business and consumer confidence are still moderating. Firms of all sizes are feeling the impact. Retail sales remain weak (despite the tax cuts). More generally, consumers have been keeping a tight rein on spending and this has hit restaurants and the travel industry. Any spare household dollars are going to pay down debt (or put in bank accounts). The residential construction downturn has further to run. The slowing global economy is not helping.
It is not all bad news. Infrastructure spending will remain strong. The shift to digitisation is creating demand for IT skills. Miners capex spending is on the rise. There will still be plenty of NDIS spending that has aided jobs growth. The RBA is looking for (a modest) improvement in the economy over the next 1-2 years. But greater fiscal support is likely to be necessary to get the economy really moving.
Business Conditions
(SD from average, 3 month average)
Number Of Dwelling Units Approved
(3 month average)
Wisest Place For Saving - Payoff Debt
Firm Views On Business Conditions By Firm Size
Labour Market
August
Employment has grown strongly over recent years and labour force participation is at a record high. There has, however, been little inroad into the spare capacity in the labour market recently, with the unemployment rate having risen slightly to 5.2 per cent. The unemployment rate is expected to decline over the next couple of years to around 5 per cent. Wages growth remains subdued and there is little upward pressure at present, with strong labour demand being met by more supply. Caps on wages growth are also affecting public-sector pay outcomes across the country. A further gradual lift in wages growth would be a welcome development. Taken together, recent labour market outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.
November
Employment has continued to grow strongly and has been matched by strong growth in labour supply, with labour force participation at a record high. The unemployment rate has remained steady at around 5¼ per cent over recent months. It is expected to remain around this level for some time, before gradually declining to a little below 5 per cent in 2021. Wages growth remains subdued and is expected to remain at around its current rate for some time yet. A further gradual lift in wages growth would be a welcome development and is needed for inflation to be sustainably within the 2–3 per cent target range. Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.
Comment:
The biggest plus is that employment growth has remained decent despite the slowing economy. The unemployment rate has risen, although a record-high participation rate has played a role. But the economy has not been strong enough for long enough. The unemployment rate is too high outside of NSW and Victoria. The forward jobs indicators do not look as positive (although that has been the case for some time).
A combination of a higher underutilisation rate (unemployment plus those working part-time looking for a full-time job) and slowing economy is keeping a lid on wages growth. Without stronger wages growth consumers’ will not be able to help drive the economy higher.
Unemployment Rate
State Unemployment Rate
(Sept 2019, 3 month average)
Business Employment Intentions
(SD from average)
Change In Jobs By Industry
(year to Sept 2019, 000's)
Inflation
August
The recent inflation data were broadly as expected and confirmed that inflation pressures remain subdued across much of the economy. Over the year to the June quarter, inflation was 1.6 per cent in both headline and underlying terms. The central scenario remains for inflation to increase gradually, but it is likely to take longer than earlier expected for inflation to return to 2 per cent. In both headline and underlying terms, inflation is expected to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.
November
The recent inflation data were broadly as expected, with headline inflation at 1.7 per cent over the year to the September quarter. The central scenario remains for inflation to pick up, but to do so only gradually. In both headline and underlying terms, inflation is expected to be close to 2 per cent in 2020 and 2021.
Comment:
The most recent CPI data suggested that the decline of inflation is stabilizing. The falling $A has played a role, driving up retail prices. But that is unlikely to last particularly given the recent pickup in the $A. A sustained rise of inflation will need either higher world prices or rising margins. Unit labour costs (wages after adjusting for inflation) has been rising but fear of competition has led to firms to so far absorb those costs. Typically higher unit labour costs is the main driver of inflation. But in the current economic environment the risk is that higher labour costs is more likely to lead to slower jobs growth. The inflation forecasts for 2021 looked to have been marked down a notch.
Underlying Inflation
(average of median and trimmed mean, annual % change)
Wages Increase By Industry
(excluding bonus, annual % change to June 2019)
Financial System
August
Conditions in most housing markets remain soft, although there are some signs of a turnaround, especially in Sydney and Melbourne. Growth in housing credit remains low. Demand for credit by investors continues to be subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.
November
There are further signs of a turnaround in established housing markets, especially in Sydney and Melbourne. In contrast, new dwelling activity is still declining and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.
Comment:
Credit growth has slowed reflecting a combination of slowing demand and tighter bank lending standards. There has been some relaxation in lending standards over recent months and that probably has a little further to run. More importantly activity in the housing market has picked up. House prices are rising again, notably in Sydney and Melbourne. The number of loans is on the up not only for owner occupiers but it looks now also for investors. The end of the decline of house prices removes one negative for consumer spending. But excess supply means that higher house prices is unlikely to lead to stronger residential construction activity.
Credit Growth
(annual % change)
Total Household Lending
(3 month average, $b)
House Price Change
(3 month sum)
Firms' Views On Net Borrowing Conditions
(3 month average)
Interest Rate Decision
August
It is reasonable to expect that an extended period of low interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target. The Board will continue to monitor developments in the labour market closely and ease monetary policy further if needed to support sustainable growth in the economy and the achievement of the inflation target over time.
November
The easing of monetary policy since June is supporting employment and income growth in Australia and a return of inflation to the medium-term target range. Given global developments and the evidence of the spare capacity in the Australian economy, it is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.
Comment:
There are two things about interest rates that is clear from RBA statements. The first is that they still have a bias to reduce interest rates. Economists agree. The November Reuters survey indicated that 26 out of 37 economists expect the cash rate to be quarter percentage point lower by March 2020 (four others expect the cash rate to be half percentage point lower by that date). At the time of writing Financial Markets are pricing about a 60% chance of another quarter percentage point rate reduction priced in by mid next year.
The second point is that rates will remain low for an extended period. Financial markets have also priced this view with the cash rate expected not to rise significantly for at least the next five years!
Date |
Financial Markets (as at 5 Nov 2019) |
Economist Views (Reuters survey conducted xxx 2019) |
||
Median |
Low |
High |
||
Dec 2019 |
0.70 |
0.75 |
0.25 |
0.75 |
Mar 2020 |
0.61 |
0.5 |
0.25 |
0.75 |
June 2020 |
0.60 |
0.5 |
0.25 |
0.75 |
Sept 2020 |
0.58 |
0.5 |
0.25 |
0.75 |
Dec 2020 |
0.61 |
0.5 |
0.25 |
1.00 |
Mar 2021 |
0.65 |
0.5 |
0.25 |
1.00 |
Sources: Reuters, Refinitiv
So this has been an unusually long period of declining interest rates. And all the signs are that we are still some distance from a higher cash rate. Yogi Berra also said ‘the future ain’t what it used to be’. When thinking about the current economy and level of interest rates, that statement certainly has more than a ring of truth about it!
We live in interesting times!
Peter Munckton - Chief Economist
