The Reserve Bank of Australia has taken a distinctively dovish turn, with the minutes from the June meeting less optimistic than its policy statement earlier this month. Nevertheless, the RBA is likely to leave rates unchanged for some time yet -- consistent with its recent statements -- but it is becoming increasingly difficult for our central bank to ignore the mounting headwinds facing the Australian economy.
Yesterday I laid out why the RBA should cut rates further. Negative real wages are beginning to weigh on household spending, and budget cuts -- mostly directed at lower-income earners -- haven't helped either.
Based on available evidence, household spending will continue to lose momentum over the remainder of 2014. Growth has slowed significantly since January and the RBA’s regional liaison suggests that it slowed further in May. Since consumption accounts for over half of real GDP, it will be difficult to maintain our recent level of growth unless households pull their weight.
Lower rates would provide some welcome relief to a household sector that has seen their purchasing power drop off over the past year. Given our high level of indebtedness, even 25-50 basis points of relief would free up household budgets and offset the rising cost of living.
The Chinese economy is also looking increasingly shaky, with its housing and financial sectors now receiving closer scrutiny, and this is placing some pressure on iron ore prices and export income (How the RBA got it wrong on rates, June 16).
With exports driving growth in the March quarter and underpinning the RBA’s expectation that growth will return to trend, our economy remains sensitive to conditions in China.
The RBA noted that "low interest rates were working to support demand", however, "it was difficult to judge the extent to which this would offset the expected substantial decline in mining investment and the effect of planned fiscal consolidation".
With each passing month it is becoming more obvious that the RBA failed to get the timing right. It is not entirely its fault (budget cuts are surely playing a role) but it will be left to do most of the heavy lifting.
We also cannot ignore how difficult it was to get the timing right. When the RBA began its cutting cycle back in November 2011, there was a great deal of uncertainty surrounding when mining investment would peak and how rapid and significant the collapse would be.
The non-mining sector remains fairly cautious and that can be seen most clearly through its attitude to investment. The RBA noted that "non-mining firms continued to report a reluctance to commit to significant new investment projects until they saw a sustained improvement in demand conditions".
The recent upgrade to non-mining investment in the capex survey provides some upside for the Australian economy (Some good news amid Australia’s capex decline, May 29). But it is also the segment most likely to be revised down if momentum slows.
The high Australian dollar remains one of the biggest obstacles for non-mining investment. The RBA noted that "the earlier decline in the exchange rate was assisting in achieving balanced growth in the economy" but that process has been limited by the dollars' "higher levels over the past few months". The dollar has remained somewhat elevated despite the sharp fall in iron ore prices during 2014.
The outlook for the economy is tentatively poised and there remains a range of headwinds that will make it difficult for growth to return to trend. I've argued that the RBA should lower rates further (by around 25-50 basis points), but obviously a lot could change in the coming months.
If the RBA is to lower rates further, then they will need a trigger. It won’t come from inflation, which remains well anchored and fairly benign, but it might come from the next capex survey in late August. That will provide a valuable update to investment intentions, the extent to which the economy has rebalanced, and provide the clearest indication yet of the timing and size of the mining collapse.