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We are changing our official cash rate view and now see the RBA cutting the cash rate twice, probably in March and April 2015 to 2.00%. We see the cash rate holding at 2.00% through to early 2016 before a set of modest cash rate increases taking the cash rate up to 2.75% by the end of 2016. The reasons for the change to our cash rate view are that the economic growth and inflation both look like staying more subdued than we thought likely previously through 2015. Also implementation of any of the recommendations of the Murray Financial Inquiry, although beneficial longer-term will come at short-term cost to the economy.
Economic reform typically slows economic growth in the near-term before boosting economic growth further down the track. The wide ranging recommendations contained in the final report of the Murray Financial System Inquiry, even if only implemented in part (the taxation changes recommended, even though they would make the tax system fairer and reduce distortions that currently unduly favour equity and residential property investment over bonds and term deposit would seem to be a challenge for the Government facing a fractious Senate) would still be likely to impact the economy in the way that reforms usually do.
Any further near-term hit to economic growth prospects presents a problem. Economic growth appears to be slowing according to the recently released Q3 GDP report showing only 0.3% growth in the quarter, down from 0.5% in in Q2 and 1.0% in Q1. Moreover real national income has declined for two quarters in row with no sign of improvement in the near term. The economy is already growing too slowly to generate employment growth sufficient to stop the unemployment rate from continuing to rise.
It is a difficult time for the Government to adopt measures that make things worse in the near-term, whatever the longer term benefits. Nevertheless, there is a reasonable likelihood that the Government will try and implement at least some of the recommendations of the Murray Inquiry. The most likely recommendations to be implemented are those relating to excessive charges on the use of credit cards and changes to bank capital requirements and risk weighting of mortgage lending.
Enacting even this limited list of recommendations would reduce the cost of using credit cards for consumers, but that benefit would be outweighed as banks pass through the costs of maintaining higher capital causing a likely lift in home loan interest rates as well as probably some reduction in their dividend payout ratios. There is a material risk that the combination of higher mortgage rates and a less assured stream of dividend income for bank shareholders – including a large number of self-funded retirees – could reduce already soft economic growth prospects even further.
The RBA will be reluctant to cut the cash rate further as it would be an admission that the near-term economic outlook has deteriorated further. However, by the time the RBA produces its next quarterly Monetary Policy Statement early in February 2015 we see the RBA having little choice but to tweak lower it growth forecasts and possibly its inflation forecasts too. Those forecast adjustments would set the scene for further small reduction in the cash rate in March and April.
By late 2015 we would expect several factors to work to lift the global economic growth outlook in 2016. A prolonged period of quite strong US growth should help boost growth elsewhere around the world. The current bout of low oil prices should serve to boost growth later in 2015 especially in Australia’s major export markets – China, Japan, India, South Korea and Indonesia all among the world’s biggest net oil importers and big beneficiaries from low oil prices. More expansionary policy settings in China, Japan and Europe are also likely to assist growth from late 2015. In short, while the first half of 2015 looks bleak for Australia, there is a good chance that conditions will improve later in 2015 and 2016. Although we see two more cash rate cuts in the first half of 2015, we see rates starting to rise early in 2016.