The cash rate remained at 2.5 per cent in September -- the twelfth consecutive meeting without a rate move -- and the Reserve Bank of Australia has again signalled a period of stability. Yet with each passing month there is mounting evidence that the Australian economy is not rebalancing as quickly or successfully as the RBA believes.
Its faith is increasingly misplaced and its belief that the economy will simply return towards trend is little more than wishful thinking. The Australian economy continues to face a number of headwinds -- which if anything have exacerbated since this time last month -- and it remains unclear whether the non-mining sector is capable of rebounding sufficiently.
The two biggest changes since the RBA met in August were the sharp rise in the unemployment rate -- which until we get the August data should be interpreted with some caution -- and the capex data, which showed that business investment is set to decline by almost 10 per cent in the 2014-15 financial year.
Whatever momentum the economy had to begin this year with has largely washed away. The household sector is stretched by poor wage growth and a soft labour market and the fear that the federal government might pass its draconian welfare reforms. I wonder to what extent the recovery of consumer sentiment is due to the federal government’s inability to get key budget reforms through the Senate?
The mining sector has been smashed by a 15 per cent fall in commodity prices since the beginning of the year, weighing on margins and profitability and causing the RBA to note that “at current prices, there is a sizable amount of coal and iron ore production that is unprofitable”. Prices have fallen further since those comments from early August.
Low interest rates continue to support lending but mostly for mortgages on existing property, which does not add to the productive capacity of the Australian economy. Credit outstanding to housing investors rose by almost 9 per cent over the year to July, compared with just 3.4 per cent for businesses. It’s been great for our banks and real estate agents but of little benefit to the broader economy.
Residential investment remains the one shining light and data earlier today indicates that the residential construction boom may be a little more persistent than previously thought (An apartment construction boom chaser, September 2). Nevertheless, residential investment is only a small share of real GDP and it is hardly the pillar upon which you want to base rebalancing growth.
Inflationary pressures appear to have peaked -- at an annual rate of 3 per cent -- and will begin to ease somewhat on the back of poor wage growth and the modest rise in the Australian dollar during 2014. The RBA believes that the dollar remains overvalued, though there is little sign yet that demand for our currency has diminished.
Naturally there remains considerable uncertainty surrounding the outlook and conditions could improve significantly from here on out. But equally likely -- or indeed more likely if the Chinese property market continues to deteriorate -- is that the Australian economy will miss the RBA’s forecasts and more support will be required.
It’d be fascinating to be a fly on the wall at the RBA boardroom right now and I suspect that member’s policy discussions are particularly animated. The RBA is obviously taking a cautious approach to policy and is reluctant to lower rates further but there is no shortage of doves within the institution.
Hopefully the Australian economy will shift gears and march back towards trend but if it outlook deteriorates further -- as has been the case over the past six months -- the RBA shouldn’t hesitate to cut rates further.