The RBA’s May rate cut will help keep households happy

Economic Insights: The RBA’s May rate cut (and more to come) will help keep households happy

Stephen Roberts, Altair's Chief Economist

The RBA’s May rate cut and the implicit promise of more to come (with most analysts adjusting their rate forecasts) provides a better chance of keeping the household sector reasonably happy.

Keeping Australian households happy

The RBA’s May 25 bps cash rate cut to a record low 1.75%, plus the implicit promise of more cash rate cuts to come flowing from the RBA’s downwardly revised inflation forecasts in its quarterly Monetary Policy Statement, is a response to the unexpectedly big lurch down in annual inflation in Q1.

There are also hints in the latest Monetary Policy Statement that the RBA has become more concerned about Australia’s economic growth prospects even though it left its GDP growth forecasts unchanged essentially from its previous set of forecasts.

The hints are contained in less optimistic comments about:

• global growth prospects;

• concerns about the durability of the early 2016 bounce in export commodity prices; and

• perhaps, most importantly, its newly expressed view that low wages growth will persist longer than it previously expected.

RBA mindful of pre-election Budget constraint…

The latest Monetary Policy Statement could not say anything about the Federal Government’s Budget announced three days earlier, but it is probably fair to say that the RBA’s economic team would have been fully aware of the constraints on what the Federal Government could offer in terms of any lift in net government spending in aggregate – virtually nothing in terms of additional budgetary stimulus to growth given the long expressed need to contain growth in government spending and debt to protect Australia’s AAA sovereign debt credit rating.

…a budget that was likely to be neutral at best for spending

The Federal Budget was at best likely to be a neutral force in terms of its likely impact on growth in Australian domestic spending over the next 12 months. At the time the Monetary Policy Statement was being drafted, it was also a near certainty that a Federal election would be called for July 2nd with an unusually long eight week campaign ahead of it. At best, election campaigns tend to be a mildly enervating force on spending by households and businesses given the heightened degree of uncertainty about what might unfold at the election and beyond.

Domestic spending may need more support

Thus when the Monetary Policy Statement was being drafted the RBA needed to adjust downwards its inflation forecasts (as it turned out reducing forecast annual inflation on all measures through to mid-2018 by between one percentage point for second half 2016 and half a percentage point beyond) and provide a sense of its concern that domestic spending may need more support to provide sufficient offset to the continuing fall in mining investment spending.

Lower inflation forecasts implies more rate cuts

The extent of the reduction in the RBA’s inflation forecasts provides the implicit promise mentioned earlier of more rate cuts to come. The half to one percentage point cut in annual inflation forecasts implies two 25bps cash rate cuts to 1.25% over the next six months or so and the possibility of even more beyond. The precise timing of the next two rate cuts is tricky, but we suspect they will come after quarterly confirmation that inflation is still very low and just ahead of quarterly Monetary Policy Statements – the August and November policy meetings are likely candidates for the next two rate cuts.

Housing and retail sales may benefit

These cash rate cuts, including the one just delivered will be aimed at improving growth prospects for the most interest-rate sensitive parts of the economy compared with what they otherwise would be. Without any interest rate cuts, household spending was showing signs of flagging. Spending on housing was losing momentum early in 2016. So too was retail spending growing in volume terms by only 0.5% in Q1 2016 and with annual change slowing to 2.4% y-o-y, the slowest annual pace in more than two years. If growth in household spending continued to moderate, Australian businesses would have no reason to lift their spending. Rather the opposite, Australian businesses facing flagging sales would have increasing reason to cut costs, including employment costs.

With interest rate cuts there is a much better chance that spending on housing will remain buoyant for longer in turn helping to sustain better growth in retail spending. With interest rate cuts there is also a greater chance that the Australian dollar will be weaker than otherwise would have been the case providing some impetus to export sales.

Sales prospects for many Australian companies have improved

The RBA’s May rate cut and the implicit promise of more rate cuts to come (it is not just us looking for two more rate cuts, most analysts are adjusting their rate forecasts) provides a better chance of keeping the household sector reasonably happy – even in the face of an indifferent Budget and a long election campaign – and in a frame of mind to spend relatively freely. The sales prospects of most Australian companies, especially those in the most interest-sensitive parts of the Australian economy- are better as a result.

ENDS

© Scoop Media