This article first appeared on the Yahoo7 Finance website at this link 


The RBA needs to play catch up – and slash rates

The pressure is building for the Reserve Bank to cut interest rates. And not just once, but several times in the months ahead.

The pick up in economic activity that the RBA has been looking for appears to have faltered. Next week’s data for GDP are almost certain to show annual GDP growth below 2 per cent and it will be lucky to be zero in per capita terms. This severe weakness in the economy is clearly why the labour market continues to operate below full capacity with record low wages growth and very high levels of unemployment and underemployment. It is not only next week’s GDP data that are causing the market to fret – recent economic news is disconcerting, to say the least.

New building approvals have been trending lower for the past year and Westpac are now suggesting that the slump in new dwelling investment will become “a material drag on growth”.

At the same time, there is tentative evidence that house prices in Melbourne and Sydney have at least topped out, or at the very least are starting to record moderate falls. House prices in most other cities remain generally weak.

In cutting official interest rates, the RBA may also want to neutralise or even offset the effect of the banks recent round of interest rate rises due to cost of fund pressures. While the RBA would probably have not been too unsettled by the upward tweaking of mortgage rates by the banks in recent months, if these moves continue and occur at a time of weak overall growth and low inflation, it may want to act to boost spending and with that inflation pressures.

Consumer sentiment remains fragile which is feeding into severe weakness in retail spending which has fallen over the last two months. Labour market conditions and for the first time in many years genuine cost of living pressures are no doubt weighing on consumers.

At the same time, recent data from Dun & Bradstreet show that firms, confronted with cash flow pressures, are taking longer to take their bills. Lower interest rate would free up some cash flow for the business sector.

Among all this, the iron ore and coal prices remain under severe downward pressure which if sustained, will undermine national income growth, profits and investment. Since peaking early this year, the iron ore price has fallen 40 per cent while the coal price is down around 30 per cent. These are Australia’s two largest exports. Over this time, the Australian dollar has been little changed, all of which presents a clear downside risk to exports and bottom line growth.

A few months ago, money markets were pricing in the risk of interest rate hikes in the latter part of 2017 and into 2018. This pricing has not only changed, but the market is expecting the next move in rates to be down, perhaps before year-end. This is despite likely interest rate hikes in the US as its economy continues to expand.

The recent run of data confirm the fact that the RBA should have cut interest rates more aggressively last year. Growth is suffering as a result. The RBA can ‘catch up’ and reset monetary policy to underpin growth which is why a series of interest rate cuts will be on the agenda in the months ahead.