Another hit and miss: The RBA has an inflation problem

Fri, 26 Apr 2019  |  

This article first appeared on the Yahoo Finance web page at this link: https://au.finance.yahoo.com/news/another-hit-and-miss-the-rba-has-an-inflation-problem-235451380.html 

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Another hit and miss: The RBA has an inflation problem

This is getting embarrassing for the RBA.

It has yet again missed its target for inflation. The March quarter consumer price index confirmed annual headline inflation at 1.3 per cent, while the underlying inflation measure saw inflation running at an equal record low of just 1.4 per cent. Recall, the RBA has as an explicit goal “to keep consumer price inflation between 2 and 3 per cent, on average, over time. The 2 to 3 per cent medium-term goal provides a clearly identifiable performance benchmark over time.”

This target and the approach to setting interest rates has served the Australian economy very well in the 25 years it has been operating. It is probably no coincidence that since the RBA adopted this inflation targeting approach to setting interest rates, Australia has avoided recession.

Alas for the RBA, inflation is falling from a level that is already too low.

For over three years, annual inflation has been below 2 per cent, which is a clear sign the economy has been weak, with firms have no pricing power because demand and spending within the economy has been sluggish. Every economist, except amazingly, those at the RBA, knows that inflation is driven by the speed at which the economy grows. If, for example, the economy is booming, it will be at full employment and wages growth will inevitably be strong. In these circumstances, inflation will be accelerating.

It is a remarkably simple linkage.

Unfortunately, and largely because of the policy failures of the RBA, the Australian economy is dogged by a per capita recession, the unemployment rate is still high at 5 per cent and wages growth is tracking around record lows. In these circumstance, it is no surprise that inflation is low and falling.

For over two and a half years, the RBA has refused to use lower interest rates to underpin a stronger economy or to drive yet lower unemployment and stronger wage increases. It is a strange choice given part of the RBA mandate is to maximise the well-being of all Australians. Perhaps it doesn’t think of the human side of having close to 1.75 million people either unemployed or underemployed. The RBA has been blind-sided by an unhealthy obsession with house prices, a poorly defined concept of ‘financial stability’ and unrelenting forecasts that inflation and wages were just about to pick up.

Meanwhile, the economy has floundered with high interest rates a clear cause. The risk is growing of a very serious disinflationary funk in late 2019 and 2020. That unpleasant scenario can still be avoided, possibly, or at least the effects minimised if finally the RBA cuts interest rates aggressively in the next few months.

It has been clear for some time now, that the RBA should have been addressing the persistent low inflation problem and the slide in the pace of growth with interest rate cuts. Over a year ago, with inflation very low and the housing sector decline well underway, interest rate cuts could have been implemented and the economy now would be materially stronger.

Alas, it failed to act.

In the wake of the shockingly low March quarter inflation result, and if the RBA is serious about meeting its inflation target, it will cut the official cash rate by at least 50 basis points in the next few months. If, when the next one of two inflation readings are released, inflation is still low, the RBA may have to cut rates a further 50 basis points to just 0.5 per cent. It is a simple truism that low and falling interest rates are a sign of weak growth and low inflation, just as high interest rates are associated with strong growth and rising inflation.

The run of economic news so far in 2019 has confirmed a per capita GDP recession and inflation falling to uncomfortably low rates. Even the unemployment rate has stopped falling. It means, quite plainly, the RBA made a serious mistake a year ago when it failed to cut interest rates but it is a mistake it can at least partly recover from with a series of interest rate cuts in the months ahead.

Get set for mortgage rates falling towards 3 per cent and possibly below that level if inflation does not pick up.

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The RBA has the tools to fix the economy, but is reluctant to use them

Thu, 05 Dec 2019

This article first appeared on the Yahoo Finance web site at this link: https://au.finance.yahoo.com/news/rba-tools-reluctant-042742904.html

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The RBA has the tools to fix the economy, but is reluctant to use them

The Reserve Bank of Australia has made a range of serious policy errors over the past few years, and the Australian economy is weaker because of those mistakes and misjudgments.

Not only is the RBA on track to miss its inflation target for six years, and perhaps longer, the persistently high unemployment rate in concert with record low wages growth is the result of the RBA’s tardiness in cutting interest rates because of its textbook obsession with house prices and household debt.

It is a mistake that has cost the economy tens of billions of dollars in lost output; employment is many thousands of people below what could have been achieved; and all the while wages growth hovers near record lows undermining the wellbeing of the workforce. What’s worse, the RBA seems to have thrown in the towel on trying to meet its inflation target, even though that target was confirmed a month ago in the recent update of the Conduct of Monetary Policy between the RBA and Treasurer.

In this context, Deputy Governor of the RBA, Guy Debelle, gave a fascinating speech earlier this week on the topic of employment and wages.

Household wealth is booming: What this means

Mon, 25 Nov 2019

This article first appeared on the Yahoo website at this link: https://au.finance.yahoo.com/news/household-wealth-booming-200022930.html 

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Household wealth is booming: What this means

$500,000,000,000.

In other words, half a trillion dollars.

That is approximately the amount Australian household wealth has increased since the start of July 2019, with house prices surging, the Australian stock market moving higher, and savings increasing.

The bulk of the gains have occurred via rising house prices, which according to CoreLogic, are up over 5 per cent in less than five months. This move in house prices has added around $360 billion to the value of housing and is driving the rebound in wealth. At the same time, the level of the ASX has risen by around 2 per cent with a further $40 billion being paid out in dividends. This allows for the recent pull back on prices as new banking scandals are exposed.

In these conditions of rising wealth, the household sector is getting a serious financial reprieve, despite the ongoing weakness in wages and the still very high level of unemployment and underemployment which afflicts almost 14 per cent of the workforce.

The good news is that this wealth creation is likely to spark a rise in household spending growth once the gains are widely acknowledged in the community and then feed into consumer sentiment. This is most likely to show up in the first half of 2020, after the usual lags work their way through the economy. History shows that when we consumers experience growth in our wealth, we are more inclined to lift our spending.

Earlier this year, RBA researchers Diego May, Gabriela Nodari and Daniel Rees found that:

“When wealth increases, Australian households consume more. Spending on durable goods, like motor vehicles, and discretionary goods, such as recreation, appears to be most responsive to changes in household wealth”.

We saw this, in the reverse, in the period from the middle of 2017 to the middle of 2019 when Australia-wide house prices fell by 10 per cent, crunching wealth levels. It was no surprise that during this period, household spending growth slumped. The retail sales component fell to its weakest since the early 1990s recession. Consumer spending and confidence was not helped by the coincident weakness in wages growth and the policy mistake of the RBA which refused to cut official interest rates, even though the economy was mired in a low inflation, low growth and falling wealth climate.

Thankfully, common sense has since prevailed at the RBA and it has cut interest rates three times since June.

Demand for housing has also lifted with shrewd first home buyers taking advantage of favourable affordability and investors also stepping back in after the May election saw the return of the Coalition government and the demise of Labor’s proposal to reform negative gearing tax laws. The current wealth surge unfolding now is occurring at a time when there is also a sharp decline in the debt-servicing burden as interest rates fall. This has the dual effect of freeing up cash flows for some consumers and allows other to accelerate their debt repayment.

For the moment, the labour market remains weak and wages are still stuck in the mud. These will constrain any near term lift in household spending, but the wealth lift will be vital for sparking a pick-up in consumption, probably in the new year when the effect is more widely observed and entrenched.

It adds to the scenario where 2020 is looking like a better year for the economy with bottom line GDP growth set to hit 3 per cent in the second half of the year.  If the wealth effects build further over that time and business investment and infrastructure spending continues to lift, the economy in 2020 just might register its strongest growth rate in a decade.