Last week we wrote about the relatively bleak outlook for employment and wages growth constraining growth in household disposable income and GDP. That outlook would make it very difficult to break out of the persistent low interest rate environment egged on from time-to-time by further RBA cash rate cuts. A break in this low interest rate cycle would seem to require a marked lift in employment growth, especially full-time employment growth, plus an acceleration in wages growth helping to prime higher inflation.

The data released last week relating to wages growth and employment remained comparatively weak. Annual wages growth stayed at 2.1% y-o-y in Q2 2016, the record low for the series going back twenty years. Employment growth was stronger than expected in July, up 26,200 but the breakdown revealed weakness below the headline reading with full-time employment down by 45,400 and part-time up by 71,600. There are no signs in the labour market and wages data that costs and potential strength in household spending are about to lift inflation.

Is there anything else that could change and drive interest rates higher? One possibility is a change in economic policies around the world aimed at stimulating stronger economic growth. In particular, much discussion is starting to occur about placing more emphasis on increased government spending to stimulate growth, mostly because of perceptions that monetary policy has become ineffective.

Over the past few years the main policy response to low economic growth and weak or no inflation has come from central banks easing monetary policy. In some cases official interest rates have been pushed below zero and unconventional easing measures have been adopted too with central banks expanding their balance sheets making regular purchases of assets – mostly government bonds but extending to mortgage-backed securities and private non-financial sector bonds – from commercial banks. The idea has been to boost commercial banks’ holdings of liquid in the hope that this will encourage more lending by banks.

Low or negative interest rates plus asset purchases by central banks may have primed buying of financial assets such as bonds and equities, but have been less successful in improving growth in commercial bank lending, or where they have been successful seem to have fuelled too much lending for housing. There is a growing sense that the lower interest rates go the less potent they become in eliciting any meaningful stimulus to general economic growth.

Senior central bankers around the world are increasingly starting to point out that government budget spending, particularly increased infrastructure spending, may be far more potent way of priming economic growth than monetary policy easing. While many governments, including the Australian government, recognise the need for more infrastructure spending, they are politically hamstrung from expanding infrastructure spending by the order needed to meaningfully lift economic growth prospects by an overwhelming requirement to contain growth in total budget spending and prevent big increases in total government debt outstanding.

As far as Australia is concerned, government debt outstanding is not high by international comparison, but a run of annual Federal Budget deficits running above 2% of GDP has led international credit ratings to warn that Australia’s AAA sovereign credit rating is at risk of downgrade if there are any signs that efforts to contain the budget deficit are slipping. If the Government were to announce a substantial lift in infrastructure spending financed by a lift in issuance of government debt, however economically worthy the projects are, a quick response would likely come from the ratings agencies reducing Australia’s AAA sovereign credit rating. Apart from the negative change to the credit rating, the Government would also need to explain why one of their core messages – balancing the budget over time to cap government debt on issue – has suddenly changed.

A move to prime economic growth via a debt-funded lift in infrastructure spending and with less heavy reliance on RBA rate cuts would seem to stand far more chance of actually achieving stronger growth. The political pressure on the Government from making such a move, however, seems intolerable for the time being. Nevertheless the idea of more infrastructure spending either with less emphasis on monetary easing or in tandem with monetary easing (so –called helicopter money) is being actively debated among economic policymakers around the world.

A move towards a big lift in infrastructure spending funded by an equally big lift in government debt could cause interest rates to rise. The likelihood of this happening in Australia in the near future is not high. Much more likely is that we get more of the increasingly ineffective RBA rate cutting. While this remains the case we see no reason to expect a consistent rise in interest rates. Instead we see good reason to expect Australian interest rates to fall even lower over the next year.