The dust is settling, at least a little, from the RBA interest rate cut.
While there seems to be a lot of noise and chatter about the decision, which surprised the bulk of the market, a few very simple points are now embedded into the economic debate.
Importantly, the growth rate in real GDP remains below trend. It is set to remain around 2.5 to 2.75 per cent, which is not horrible, but is some way below a healthy 3.25 per cent pace. No one I know can create a scenario where GDP growth gets above trend in the next coupld of years. [This is why the RBA is still likely to cut to 1.5 per cent.]
Given the large and growing output gap, it could be argued that the economy needs to grow at 3.5 per cent for a year or two before there is any risk of an uptick in inflation pressures.
From this problem of below trend growth, most of the other uncomfortable economic facts flow.
A subdued rate of growth means that employment growth is, by definition, not going to be strong enough to stop the unemployment rate from rising. This has been the case for the past couple of years and for 9 months now, the unemployment rate has been 6.0 per cent or higher. This rising unemployment rate in turn means that wages growth is depressed, reducing the purchasing power of the household sector and crimping overall demand. This softness in spending then feeds into softer economic growth, weakness in the labour market and so the cycle goes on and on.
A circuit breaker was needed and this is coming in the form of lower interest rates and a sharply lower Australian dollar. Fiscal policy, it seems, will not be directed at growth although this may change if there is a new Prime Minister and Treasurer in the days and weeks ahead.
With the previous 2.5 per cent cash rate obviously too high to deliver a 3.25 per cent plus real GDP growth rate, this week’s cut to 2.25 per cent will need to be followed up with more cuts in the months ahead. In other words, get set for a 2.0 or even 1.5 per cent cash rate later this year.
With that and the general malaise in terms of trade, the Australian dollar is also more likely than not to fall. It has already dropped a massive 32 cents from the peak which means that the next bout of weakness could well signal a cyclical low. For me, that low looks like being around 70 US cents which if reached and sustained a while, will help set the economy up for a stronger 2016. The only question is how strong, with 3.25 per cent a minimum requirement if we are to ever see unemployment drop back below 5 per cent.
