French journalist and novelist. Jean-Baptiste Alphonse Karr coined the term “the more things change, the more they stay the same” back in 1849. In June 2015, speaking in Brisbane, RBA Governor, Glenn Stevens seemed to be having a Jean-Baptiste Alphonse Karr moment. He started his speech,
“The last time I spoke with this group, in July 2013 the economy was estimated to be growing at about 2.5%. Underlying inflation was 2.25% – 2.5%, consistent with the target of 2-3%.
Two years on, the economy is growing at just shy of 2.5% and underlying inflation is around 2.25% – 2.5%, consistent with the target.
In some respects, then, it might seem that not much has changed.”
Governor Stevens then provided a list of the many economic elements that had changed over the past two years and many very differently from what the RBA had forecast back then. The key point though was that in aggregate and notwithstanding a few prods from easier monetary conditions including a lower exchange rate, the economy is still in much the same condition, if not a little weaker than it was two years ago – still operating below trend growth and with excess capacity and needing additional demand from somewhere.
Governor Stevens also noted that there are limits to how much of that additional demand can come from the household sector carrying a heavy debt load. While the RBA remains open to easing monetary conditions further if needed it also recognises that encouraging the household sector to become even more highly leveraged may lay in store potential future risks to sustainable economic growth.
Australia’s opportunity for stronger, sustainable economic growth rests more with businesses investing more and with government actually borrowing more for well-considered infrastructure projects. Training and education will also be important in unlocking growth opportunities. Progress in these areas is very patchy and in some cases very weak, such is in business investment spending.
Our take on Governor Stevens’ comments is that the problem of soft growth is unlikely to diminish in the near, or even medium-term future. One near-certainty in this difficult economic environment is that the cash rate at 2.00% is unlikely to rise over the next year or so, even if the US Federal Reserve starts a process of normalizing its interest rates later this year.
There is a reasonable probability, however, that the RBA will lower the cash rate at least one more time. We still favour a 25bp cash rate cut to 1.75% at the early August RBA policy meeting.
With the RBA still more likely to cut the cash rate further and with almost no possibility that the cash rate will be any higher than 2.00% over at least the next 12 months, the selling pressure in the Australian government bond market driven almost entirely by international influences (mostly shifting market views on when the Fed will start raising rates) more likely than not will fade and part reverse in our view. There is also a strong likelihood in our view that the yield spread between our bond yields and those in the US will compress.
The next fortnight or so could be a volatile period in global bond and equity markets. The US FOMC meeting this week may firm up guidance on when the first rate hike is likely to be (although with no change at this meeting and further reassurance that when rates start to rise the process of normalization will be a cautious affair). In Europe, discussions around Greek sovereign debt may well reach an ultimatum at a Euro-area finance ministers’ meeting later this week.
Whatever the outcomes of these important international events it is worth keeping in mind the RBA’s view about the Australian economy – not much has changed over the past two years or is likely to change over the next year or so. The case for low interest rates persisting in Australia is a very strong one.