Ahead this week: The 2, 2, 2, 2 and 9 economy

Sun, 31 May 2015  |  

It’s a big week for economic data and events.

We are likely to see the RBA hold the cash rate at 2.0 per cent, annual GDP growth weaken to just 2 per cent, annual inflation to come in at around 2 per cent, building approvals drop 2 per cent and annual growth in house prices to jump to 9 per cent.

These indicators are not good news on the economy. 2 per cent GDP growth is poor, inflation near 2 per cent is too low and the house price imbalance remains a bigger threat to the long run well being of the Australian economy than any weakness in commodity prices or slowing in the Chinese economy.

It would be a disaster for house prices to fall away over the next couple of years as it would be if house prices keep rising by 9 per cent per annum over the next few years. It is a lose/lose situation, it seems. It remains a pity that the RBA didn’t cut interest rates more aggressively in 2012 and early 2013 when it was obvious the terms of trade were falling and the Australian dollar was overvalued. It could then have hiked in late 2013 and early 2014 to send a powerful message to house buyers that interest rates do not always go down and stay low. Obviously, recent cuts would have been delivered, but such a strategy that may have dealt with the housing problem and compensated for the terms of trade decline.

Indeed the last interest rate rise was in 2010, almost 5 years ago. Many people have seemingly forgotten about the risk of higher interest rates. The RBA, by passively sitting by and not cutting enough, not hiking and then not cutting have failed to use monetary policy as a tool for managing demand and inflation over the cycle. It is like sitting in a car and rolling down a hill in neutral - neither accelerating nor breaking as needed.

Which leads to the problems that will be evident this week. Runaway house prices, weak GDP growth and inflation at the bottom of the target range demand high, no low, no high, no low interest rates. Here is the RBA’s dilemma.

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