The rosy forecasts from the Reserve Bank of Australia and Treasury published just last month are a pipe dream. Investors know this and are selling Australian dollars and buying government bonds as a result. No credible forecaster believes the RBA’s growth and wages forecasts. This assessment has driven an about-face in market expectations for official interest rates.
Investors and the market are treating the RBA forecasts and rhetoric – that “the next move in the cash rate is more likely to be an increase than a decrease” – with disdain. Interest rate futures are pricing in the strong possibility of an interest rate cut in late 2019 or early 2020, with the economic growth deceleration, problems with wages and the failure of the RBA to meet its inflation target as primary reasons. A slowing in global growth is also impacting.
If the RBA is to deliver a decent and sustained trend rate of economic growth – that is one that will underpin an economy that will deliver an improved and tighter labour market that in turn drives an acceleration in inflation back to the mid-point of its target range – lower interest rates are needed.
The RBA board next meets on 5 February, and if it is to maintain a semblance of credibility, it will drop its rose-coloured view of the local economy and acknowledge the downside momentum unfolding before its eyes. It will need to flag the need for easier policy. The dollar is set to take another hit on the back of this change in official view.
Also impacting the value of the Australian dollar are the increasing weighty problems in the Chinese economy. China takes around one-third of Australia’s merchandise exports, which makes it a vital part of any assessment of the economy and the Australian dollar. Chinese economic growth has slowed to its weakest pace in two decades and a further slowing in 2019 is assured. The trade and tariff war with the US is undermining the manufacturing sector and to the extent the major buyers of Chinese goods are also experiencing a stalling in growth, the global outlook has taken a turn to the downside.
The economies of the US, eurozone and Japan are also slowing and registering worryingly low inflation, particularly in the context of how stimulatory monetary policy has been for a decade or more. The Bank of Japan and the European Central Bank are keeping monetary policy tilted towards extreme stimulus, notwithstanding occasional rhetorical flourishes from some of the more hawkish members of each institution.
Even the US Federal Reserve, which has hiked its interest rates to 2.5% over the past two years, is poised to pause its rate-hiking cycle. It could even reverse some of those interest rate hikes later this year as the US economy enters a period of more problematic growth and severe budget problems.
In simple terms, the Australian dollar tends to be strong when the global economy and local economic growth is strong, and it tends to fall in times of economic weakness. What we are witnessing now is no different from this well-established trend.
The 10c decline in the Australian dollar over the course of the past year is well within the range of normal moves seen since it was floated in 1983.
Given the unfolding slump in housing, the labour market, global growth and the major commodity price indices, we might see something close to another 10c decline in the Australian dollar over the year ahead.