Why the RBA refuses to cut rates

Fri, 08 Sep 2017  |  

This article first appeared on the Yahoo7 Finance website at this link: https://au.finance.yahoo.com/news/1714473-004126949.html 


Why the RBA refuses to cut rates

The forecasting record of the Reserve Bank of Australia is poor, but that has not stopped it relying on its forecasts, rather than hard data, when setting monetary policy.

In the past year where interest rates have been left unchanged at a level that is amongst the highest in the industrialised world, the RBA has been banking on its forecasts for stronger economic growth, a lift in wages and rising inflation to validate its failure to join the rest of the world with ultra low interest rates.

There are a couple of consequences of this approach from the RBA.

Importantly, despite its status, the RBA is made up or mortals. Sometimes its forecasts are wrong. And in recent years, the RBA forecasting record has been wide of the mark on growth, wages and inflation.

As the data has unfolded through the course of the past year or so, contrary to the rosy outlook from the RBA, economic sluggishness remains the order of the day.

Annual GDP growth is just 1.8 per cent, one of the weakest growth rates recorded in the last 25 years and now one of the weakest in the industrialised world. At the same time, wages growth has never been lower, at just 1.9 per cent. The level of labour underutilization – that is the sum of the unemployment rate and the underemployment rate – is over 14 per cent, a level usually seen when the economy is near recession.

Inflation, which after all is the main target of the RBA, is in underlying terms running at 1.8 per cent, and has been below the bottom of the RBA target range for almost two years. In the current global environment of low inflation, it is difficult to see Australia’s inflation rate moving much higher over the near term and has close to zero chance of exceeding 3 per cent, the top end of the RBA target range.

At the same time, Australia’s high interest rates relative to the rest of the world are a magnet for capital inflows to the point where the Australian dollar has rocketed back to 80 US cents. If sustained, this will act to dampen export income and will make it harder still for local firms to compete with importers.
In other words, an inappropriately high Australian dollar is working to slow an already soggy economy.

It is also quite clear that housing construction is cooling. This is not good news, not just for the next year or two of GDP, but it risks leaving Australia with a housing shortage if new construction lags population growth and other demographic changes. Lower interest rates would encourage new construction.

Everyone knows that changes in interest rates impact with a long and variable lag. That is, it takes something around 3 to 18 months for a change in monetary policy to impact on the economy. As such, forecasts are always going to be part of any policy deliberation.

But when the data confirm the forecasts of a year or two ago are consistently wrong and the errors are all in the same direction, remedial action – ie a policy catch up is needed.
In the mean time, the weak economic growth leaves around 725,000 people unemployed, and around 1.1 million underemployed. Had the RBA been a little more reactive to the data and less taken with its rosy forecasts and it had cut interest rates further to boost the economy, the number of people suffering for the lack of work would be materially lower.

And worryingly, the latest noises from the RBA suggest it is still upbeat about the outlook and has no inclination, at all, to cut interest rates.

This means that growth and jobs will be lower than need be for a while to come.

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Why the RBA is wrong, wrong, wrong

Tue, 14 Nov 2017

This article first appeared on the Yahoo 7 Finance website at this link: https://au.finance.yahoo.com/news/2024247-032933611.html 


Why the RBA is wrong, wrong, wrong

The latest Statement on Monetary Policy has confirmed the failure of the Reserve Bank of Australia to implement monetary policy settings that are consistent with its inflation target and objective of full employment.

It used to be the case that the RBA could never have a medium term forecast for inflation other than 2.5 per cent – the middle of its target range. The thinking was that if the RBA had a forecast an inflation rate of say, 1.5 or 3.5 per cent, that was based on current policy settings, it would adjust interest rates to ensure inflation would not reach those levels, and instead would return to the middle of the target.

The middle of the target range is an important goal for policy because it means the risks to the forecast are symmetrical. A forecast of, say 2 per cent, means that a 0.5 percentage point error could see inflation fall to a troublesome 1.5 per cent as much as it could rise to a perfectly acceptable 2.5 per cent, while a forecast of 2.5 per cent that turns out to be wrong by 0.5 per cent would still mean the RBA meets its target.

And even if the 2.5 per cent forecast turns out to be wrong as economic events unfold in ways not fully anticipated, it would adjust policy again to keep the focus on the 2.5 per cent. The RBA did this well until the global crisis came along and changed the growth, wage, inflation dynamics.

Which is where the recent RBA policy settings have been so wrong.

It has been well over a year since the last interest rate cut.

Getting out of property and into stocks?

Thu, 09 Nov 2017

Getting out of property and into stocks

That seems to be a theme developing in the Australian market at the moment, with further evidence of a cooling in the housing market and a coincident lift in the value of the ASX hinting that those with money to invest are avoiding the ultra-expensive, low yielding housing market and instead are looking to the stock market for opportunities.

The Australia stock market is moving higher to the point where the ASX200 index is poised to break above 6,000 points for the first time since 2008. The past decade has been a rocky one for the Australian stock market. There has been the GFC, a commodity price boom and bust, speculators have jumped into and out of bank stocks based on extreme calls on the housing market and many local firms have been dealing with an unrelenting threat from foreign competition.

Some of these issues remain, but a combination of factors appear to be at play in the new found interest in the share market.