Complacency masks severe risks for the economy

Mon, 22 Sep 2014  |  

It is very odd that the vast bulk of economists and market participants are content forecasting ongoing moderate economic growth, a topping out in unemployment and on-going pressures on inflation that will see it remain near the upper part of the RBA target.

Very odd because it is increasingly clear that the RBA will need to cut interest rates in the not too distant future as it rides to the rescue of faltering growth, deflationary pressures and stubbornly high and possibly still rising unemployment.

The commodity price free-fall continues unabated which is crunching national income and risking deflationary pressures in the economy. Iron ore, gold, coal, to name a few, are seeing prices fall to levels that threaten the cause market ructions for local producers.

Critically, consumer demand is soft and as the Dun & Bradstreet Consumer Financial Stress Index shows, the pressures on consumer finances remains squarely to the down side. Rising unemployment and falling real wages are a cocktail of poison that spell a rotten few months ahead for retailers.

What is also important for the RBA is the stable to slighter weaker outlook for the global economy. The US looks to be travelling at a decent clip, but there are large and arguably growing risks with the strategy of the Federal Reserve as it moves to a monetary policy tightening cycle. Chinese GDP is certainly not accelerating and if anything, could be slowing to a point where GDP growth will slip below 7 per cent by year end. Then there is the Eurozone which has remained mired in a recessionary funk with next to no prospects for stronger growth.

At home, there seems little doubt that the "terror threat" will hurt consumer sentiment and with it spending, compounding the concerns for consumer finances outlined above. House price growth is clearly slowing, new construction is flat at best and government demand, which makes up around one-fifth of GDP, is a handbrake on activity.

What's more, the stock market looks to be heavy with resources and banks are getting hit more than most. The gains for 2014 are almost gone.

The case for lower interest rates is more than circumstantial, even though the RBA seems reluctant, at the moment, to move down that path. It might take a very low CPI or two, a 6.5 per cent print on unemployment and a few months of zero house price changes (or price falls) for the RBA to act. In the past 5 years or so, the has been reactive as opposed to preemptive when it comes to monetary policy settings. Maybe it needs to see the wheels fall off the economy before it acts.

This suggests an interest rate cut or two in early 2015 is more likely than not, once the penny drops that the economy is in need of a policy pick-up. Let's hope it is not too late to prevent sub-2 per cent inflation and an unemployment rate nearing 7 per cent.

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