Collectively the economic data was largely consistent in December and was supportive of our conclusion in November that the Australian economy may have reached a turning point to a worsening outlook. Recent economic data shows the previous long-term trend of the Australian economy being on a path to slow improvement where increased employment growth eventually leads to higher wages pressures that boosts demand and leads to increased inflation, now looks under threat. However, we caution one or even two months data can easily reverse and that to make firm conclusions we would be looking for a longer term trend to be established.
While the RBA again re-iterated in its monthly board minutes in December the next move in interest rates is more likely to be an increase than a decrease, it seems any interest rate move is now many months away. ANZ joined Westpac in December in pushing back its forecast of an interest rate rise out to 2020.
We broadly agree with these views and see the RBA as very much on hold in the medium term. Our view is the RBA does not want to create a “moral hazard” situation where they are seen to be cutting interest rates to support a falling housing market. Our belief is the RBA wishes house prices to continue their downward trend so long as this does not push the broader economy into a very low growth or even recessionary scenario with the rationale that an orderly house price decline removes one of the largest risks to the economy. In addition, investment in housing is not generally viewed as being as economically productive as either consumption or business investment in the longer term, so lower house prices are desirable for the longer term health of the Australian economy.
Recent economic data provides no justification for an increase in the cash rate. This means the RBA is largely “boxed-in” at the current cash rate level of 1.50%. The only realistic scenarios that would cause either a move up or a move down in the cash rate are as follows. To justify a move upwards, the economic data from the last few months will need to be proved to be an aberration with the Australian economy moving back towards a path of falling unemployment beginning to exert wage pressures which in turn causes consumer price pressures, allowing the RBA to increase interest rates to control rising inflation. To justify a move downwards, there will need to be a further fall in domestic house prices possibly coupled with a global economic downturn such that this would push the Australian economy towards recessionary levels at which point the RBA can argue it was saving the Australian economy rather than the housing market with interest rate cuts.
Neither of the above scenarios looks at all imminent, although one of the two is almost certainly to eventuate as it is unlikely Australian interest rates will remain at 1.5% over the longer term.