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Ben Kingsley Blog post by Ben Kingsley

RBA Cash Rate June 2019: The Cash Rate Announcement We’ve All Been Waiting For

Today Governor Lowe and the Reserve Board met and, yes, we have a rate movement.

That’s right — a 25 basis point cut, bringing the cash rate down from 1.5% down to 1.25%.

For all you data nuts, I’m going to give you a little bit of a backstory in regards to where the cash rate has been. So it is the first rate move of any rate movement since 2016 — August 2016 was our last rate move.

Now, our last rate move UP was way back in September of 2009 and that’s when the cash rate moved from 3% to 3.25%. That was part of a tightening cycle that saw the rates move from 3% right up to 4.75% and that finished in November of 2010, and that’s when we saw a basically flat period. Then from November 2011, we started to see our first rate cut in this particular cycle. So, we’ve had two rate cuts actually since November of 201.

Today we have a cash rate of 1.25% — now the question is: is that all? Is there more to come? I’m going to answer that in a little bit later, but I want to talk about how we got this position. Because, remember, these are were supposed to be emergency rate settings.

 

But globally around the world we’ve seen that lower interest rates are going to be here for a lot longer. And we’re not seeing the material impact that we would normally see when we move monetary policy.

What are we talking about there? Well, normally, as you bring the cost of money down, you get inflationary pressures; you get business investment and those types of things. We’re not seeing that inflation flow through. So that is the big key reason why we’re seeing the Reserve Governor move, in addition obviously to a slowing economy.

 

I’ve got my three reasons why we’ve been in this slower GDP environment.

Firstly, the lever for this was back in 2015/2016. We had a booming property market and that was causing all manner of concern because, basically, the whole infrastructure around the economy is underpinned by residential property and our wealth in the residential property space. We were getting too heavily in debt and so the macro-prudential interference by APRA started way back in December 2014. And they continue to do more and more work there. So that slowed the property market, probably too far. So now we’ve got an impact of consumption slow down — that’s The Wealth Effect I’ve talked about many times before. So we’re now going through that, and we’re going to see some incentives there, which I’ll talk about in a minute.

The second one — if we cast back to the first half of 2018 I’ve talked about this also — we had an economy moving at around 4% annualised growth and so we were talking about rate rises at that time. But we did see the federal Liberal Party implode after they sacked Malcolm Turnbull and they also moved away from their NEG, which is the National Energy Guarantee policy.

So if you’re listening ScoMo, and everyone in the Liberal Party — bring back the NEG. I’m glad to see you back in power to be able to move the economy forward, but you’ve still got some work to do there.

In any type of federal election, there is usually uncertainty about what’s going to happen, and we definitely saw that in regards to Malcolm Turnbull getting knocked over. And that was obviously the third concern. Business confidence suffers; the cost of energy was going to be a problem for investment in businesses in this country. So we did see that play through. Add to that that the Labor party’s agenda around large reform, higher taxation and we did see business confidence start to wane. We’re going to see a bounce in business confidence and I’m going to talk about where that bounce is coming from now that we have certainty around our Federal Parliament for the next three years.

 

I also want to talk about some of the language that’s being used by the RBA, in regards to how we got to this position around GDP and some other concerning things.

So I’m going to read from their quarterly Statement on Monetary Policy because I think there are some extracts in here that give us a few clues as to why this has occurred. I’m trying to keep this into layman’s terms to make sure we can get an understanding of what’s happening. In the overview they talk about Gross Domestic Production — so growth — in the Australian economy has slowed and inflation remains low. Subdued growth in housing income and the adjustment in the housing market has affected consumer spending and residential construction — and that is the big piece here.

Okay, so they’ve led them as they’ve seen them. They’re basically saying that this is the biggest problem we’ve got around consumption because consumption, remember, is 60% of GDP. It goes on say: Despite this, the labour market is performing reasonably well. We’ve got unemployment around that 5%, and the underlining inflation — which is what they’re trying to push up — has been lower than they expected at around 1.5% over the year to the March quarter, with pricing prices subdued across the economy. GDP growth is expected to be around 2.75% over both the 2019 and 2020 period. Now, this is lower than they previously forecast. So both the RBA as well as Treasury are now saying that that growth is going to be a little bit low, effectively saying, reflecting the revised outlook for the household consumption, spending and dwelling activity, stronger growth in exports.

 

So, in terms of iron ore prices — we can see those at around $108 to $110 dollars a tonne. What’s caused that? Australian iron ore is the best iron ore in the world and there was a very bad incident over in Brazil, where the other good iron ore exists —they had a dam collapse  — and so the production of iron ore in Brazil has been tapered. And so the Australian needs of that iron ore into China are really big, and that’s what’s pushing the prices high and that’s bringing in an incredible amount of revenue into the federal coffers at the moment. That’s also on top of the of the fact that the Chinese government has introduced some stimulus in terms of infrastructure spending, which requires an enormous amount of steel and cooking coal. So that’s obviously why our ore and our coal are doing so well. Considering the estimates that we had in all of the budget around what the price of iron will be — we’re well and truly above that. That’s obviously meant greater revenues coming in to the federal coffers.

So it’s important to understand that’s why they’re adjusting that in terms of CPI — so that’s the Consumer Price Index — which is the inflation measure. They’re saying that could be below 2% and they see this potentially adjusting in 2021/2022, so we’ve got this low inflation rate, which is problematic. We need to get that up. We need to get jobs growth. We need to get pressure on that to get the income flowing through. So I’ll finish off, in terms of the GDP story, with this: it says GDP growth was softer than expected over the second half of 2018 because of the uncertainty in our political environment. This meant businesses weren’t willing to spend after strong first-half growth. Consumption growth has slowed especially for those with the discretionary items, which tend to be correlated with housing conditions. So this is the extra spending that we do when we feel comfortable about our properties going up in value.

But when our properties are going down in value and we are uncertain about our jobs, we keep our hands in our pockets.

 

This obviously affects spending, which then affects employment, and so on. That’s the big factor here. Some temporary factors are also waiting on growth — we had the drought conditions constrained rural production, supply disruptions affected resource export,s and the winding down of near completed liquid natural gas projects weighed on mining investment consumption. Dwelling investments are expected to remain soft in the coming quarters.

Now that’s an interesting sentence for me — consumption and dwelling investment are expected to remain. I think that with some of these rate cuts, and obviously the fact that we run a business that helps people buy property, we’ve definitely noticed an increase in enquiry. It is remarkably different to what we saw in April compared to what we’re seeing post-election. I’ve talked to a few other industry people as well, and they’re also seeing that noticeable increase.

You’re not going to see that, and this is one of the important messages I also want to talk about today — we’re going to see GDP numbers for the March quarter be released tomorrow. There’s a lot of expectation that those GDP numbers could show a negative or zero growth for the March quarter. So just be mindful that this is a lag indicator, okay? It’s reporting on what’s happened for the previous quarter. So we’re going to see a bit of GDP numbers being a bit sluggish because we need to build that momentum back up again.

So when you are looking at and reading the newspapers and seeing the reports in the media around the economy, just be asking yourself, “Is that a leading indicator or is it a lag indicator?”

Because it’ll take a little while for the numbers to improve in the lag indicators. But some of the leading indicators are also going to be important — and I’ll talk about those as I close out this presentation. So that’s where we sit. Hopefully we’ll see some rain in our rural areas, and our rural production will increase, and then we see a modest pickup in mining investment is expected to support growth

This is the bounce I want to talk about!

So let’s go through some of the subtopics we were talking about. In regards to unemployment — again there’s some commentary in the Statement of Monetary Policy in contrast of the signals coming from the National Accounts — a number of labor market indicators remain positive. So they’re really happy about this. Employment growth is strong in the March quarter, following similar outcomes over much of 2018. The vacancy rate remains high and there are ongoing reports of skill shortages in selected occupations. That’s a good news story.

When we talk about wages growth, we’re talking about income growth. We need to get this wage growth. We also saw last week that the minimum wage is going to be increased from 1 July by 3%. So that means our lowest earners are going to get a 3% pay rise from the first of July. If we also a couple in the tax cuts, which means we’re going to get a one-off payment for minimum, low and middle-class incomes, we’re going to see around a $1,080 payment per worker. So if you’ve got 2 lower/middle-class workers, you’re going to see potentially $2,160 being delivered into your bank accounts over the course of the coming months.

[Recommended reference: Changes announced in the 2018-19 Budget on Income Tax]

If you think about what the Rudd Government did with a $900 incentive during the GFC, it will flow through to retail spending and also stimulate the retail growth we’re looking for.

 

The RBA believes that the unemployment rate will remain around that 5% — but what was really important in Governor Lowe’s speech that he delivered last week is that they want to push this story harder. They need to see a 4 in that number because what they’re saying, based on innovation and the digital age and productivity improvements, is that we’re getting through technology — we’re not seeing those wages growing. So we need to push really hard into the fours, in terms of an unemployment rate, to try and push wage demand and get wages increasing, which is only good for prosperity and also good for the economy.

I want to move into that. So, we were just talking about wages, in terms of household income, and this is what they said in their March statement: weak growth in household income poses a key risk to the outlook for the household consumption, especially in this context of falling house prices and the need for many households to service higher levels of debt. So if you think about it logically: if we have a record level of household debt, it means that a lot of our discretionary money is being spent on interest costs. And we don’t want that. So we get some of that debt down, or we get a pay rise. And then ultimately we can start to increase our discretionary spending. And that’s good for economic growth and economic prosperity. So that’s an important message there.

The other important point there was “in the context of falling house prices” — so if we can see the bottom of the property market, then ultimately we might see a little bit more confidence in people starting to do their discretionary spending as well. So that’s an important message.

That’s where we sit in regards to what’s been happening in the economy.

 

I also want to note that obviously the rate cut has just happened.

So I’m now talking to the bankers here who are listening: if you don’t pass on the full 25 basis points then you are lying to your customers — and I mean that very directly, okay? — there is absolutely no justification at all in terms of not passing on the full rate cut.

I’ll use an extract again from the Statement of Monetary Policy where Governor Lowe is telling you — and I’m sure the politicians are telling you  — and I’m telling you as well: Conditions have also eased in domestic financial markets, with government bond yields falling to historical low levels. In fact, last week the 10-year bond rate fell below the cash rate; in terms of 1.5%. The 10-year bond, the Government bond, got below that. That’s never happened before. So this is signaling to you that there could be even further rate cuts coming, and we’ll talk about that shortly.

So it says here: … falling to historical low levels and equity prices have risen strongly. In addition — and this is for you bankers — pressure on short term money markets has eased, reducing banks’ funding costs. Banks bill spreads are now at their lowest levels since late 2017, though this has not flowed through to most advertised mortgage rates.

That’s why we’re talking to you. You have absolutely no reason not to pass on the full 25 basis points cut to all mortgage holders. So I’m putting it on you banks: the pressure’s there, so there is no justification not to pass on that full rate cut. No excuses.

 

Now, let’s talk about future rate cuts.

Again, we saw some evidence around what Governor Lowe’s speech last week around inflation — if they are going to go after inflation, they need to go after that by basically doing a second rate cut, which most economists are thinking is coming in August.  There’s even some commentary around a third rate cut, which will take the cash rate below 1%.
There are even some people forecasting that the cash rate will get as low as 0.5% — now I’m not in their camp as much because I think what we are seeing out there is confidence. In all the business leaders I’m talking to, it has definitely turned — we now have, as we talked about before, some stability. We now have ScoMo in power, who’s more center-right than far-right. If he can organise our energy policy, I suspect there’s going to be even further confidence in the economy, and that’s a good thing. That means that the RBA may not need to do as much of the heavy lifting in reducing the cash rate.

 

There’s a couple of challenges here in getting the balance right. The first thing is: do we want to see the property market start to go crazy again? And the answer to that is absolutely not. So, we want to see a steady level of growth — we don’t want to see a boom/bust type arrangement when it comes to property prices.

The levers that the RBA, APRA and the banks pull are going to play an important role. So if we do see further rate cuts throughout the course of the end of this year and maybe even into the new year, where we do get to below 1% cash rate, we’re going to see the banks and APRA be very careful about their settings around making sure that borrowers can’t borrow too much money. How will they do that considering they’ve recently announced they’re going to reduce the 7% ceiling and introduce a 2.5% margin on top of what is the retail rate that consumers are paying?

They’ll call that the assessment or serviceability right now. So if rates are going lower, it means that assessment rates are going to come down, which means borrowers are going to be able to borrow more money. How do we counteract this? Well, how lenders might look at and explore a review of household spending, and they may increase that a little bit, in terms of the minimum spending expenses they put in those applications. This is a good thing because we won’t see a blowout, in terms of what people can borrow.

 

 

Even though that will help with construction and consumption, we need to ease our way back into it. And if we think about the construction industry as a whole, we’ve lost a lot of those foreign buyer. So there’s still going to be some challenges around getting medium and high-density construction off the ground because they need to get those minimum pre-buys, those pre-sales, to get confidence in order to get the lending from the banks to actually build those particular properties.

 

We’ve covered a lot of ground in this presentation and the reason for that is because, obviously, this is a big move and it’s showing that there is potentially going to be a further easing as part of this cycle. So I think that’s an important message for all.

I want to finish on just one important point: How do we know that we’re getting this consumption bounce?

 

Before I said, “Don’t panic about some of the economic results that you’re going to see over the course of the next couple of months because they are lagging indicators.”

The leading indicators that we really are interested in are these ones here:

In terms of building approvals, we want to start to see that come back off its historical low. We want to see some building approvals start to flow through because it takes time for those approvals to actually then be approved, planned and constructed. So we would see we’d like to see an improvement, in the second half, of approvals and then into the New Year, when we also see the introduction of the federal government’s First Homebuyers Deposit Scheme, which is also going to have some stimulation, in terms of allowing people with less deposits to get into the market. So we should also see some improvement. This was only for 10,000 households, but we’re potentially going to see that open up a little bit more if Josh Frydenberg is true to his word — if it’s successful, they might introduce it. So construction building approvals is number one.

[Recommended reference: First Home Loan Deposit Scheme]

Number two: business confidence. We want to see a spike in the business confidence, and we saw a little bit of that in some data from last week around the expectation on expenditure from businesses. So the numbers washed up at around a 6% increase in business investment. In business expenditure in the 1920 and 2021 period, I think this might even bounce a little bit more as there’s a little bit of confidence moving in. I know in our business, we’re looking to employ people now, as opposed to when the election came about we were concerned about what was going to happen to the property market and whether we could maintain the level of people that we have in our business. I know we’re a sample of one, but it just gives you an indication of the ripple effect that will occur across the country.

Also, consumer confidence. So we want to make sure that consumer confidence, on the back of business confidence, starts to also show up in the numbers over the course of the next couple of months. And then finally retail spending once we know that’s happening. We know that consumption and mindset and The Wealth Effect has passed, where we’re keeping our hands in our pockets and we’re moving forward. They are the main ones. Now, the correlation, the flow-on of this, is obviously seeing the unemployment rate start to go down. Because once we do get consumer confidence and retail spending, we employ more people and as we do that, the unemployment rate will go down and we’ll start to see GDP improve.

 

So it has been a very, very long presentation. If you’ve hung around to the end, thank you for doing that. It’s going to be an interesting time with further rate cuts anticipated through this year. Definitely one more, and the prospects of a third rate cut. We’ll just wait and see how those indicators, and those reports and indexes, start to show up. But definitely, an easing policy where we’re going after inflation and that’s a good thing for economic growth and for economic prosperity.

Thanks for watching.

 

 

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