RBA Pushes Government to Take Action
A clear request for greater structural change in the economy shone through in Reserve Bank Governor Philip Lowe’s discussion with the Economic Society of Australia in Brisbane yesterday. During the questions session, some firm suggestions to take action were put to Prime Minister Scott Morrison. Lowe’s intense analysis of the health of the economy has led him to a firm conclusion that changes to monetary policy would not be sufficient to resolve the need for more stimulus and economic growth. He noted that the cash rate is already extremely low at just 1.5 percent, thus cannot be cut much further. A major fear is whether any increase in the unemployment rate is on the cards with April’s data showing an increase to 5.2 percent from 4.9 percent earlier in the year. Lowe’s focus was primarily on the need for change to encourage businesses to hire more people, invest more to expand and to foster innovation.
Signs of a cash rate cut in June are more evident than ever with market pricing now factoring in a 70 percent likelihood. A strong consensus has been that the federal election had a strong impact over the decision to keep the cash rate on hold this month due to the fact that either of the major political parties could have manipulated such an announcement to their advantage. The RBA did not want to play political games. As a result, is the likely rate cut in June therefore overdue? Inflation data for the first quarter was at its lowest rate since the third quarter of 2016, falling to just 1.3 percent from an already weak 1.8 percent in the previous quarter last year. University skeptics have been calling the RBA’s target inflation rate of 2-3 percent as a bit of a joke given the lack of action taken. If unemployment continues to rise, a rate cut could be too little too late.
The RBA has explicitly flagged that lower interest rates will be discussed at its upcoming meeting with a rate cut extremely likely. Philip Lowe himself, almost out of character, stated, “A lower cash rate would support employment growth and bring forward the time when inflation is consistent with the target.” But he remains adamant that some issues are not for monetary policy to address. His belief is that the tax system is the ultimate driver of economic growth. The election outcome has made it clear that households prefer stability and continuity. But when considering what’s best for growth in the economy, the RBA is clearly of the opinion that growth is sub-optimal currently.
Scott Morrison has indeed promised some clear tax reform with income tax cuts up to $1,080 offered per person. This positive increase to households’ disposable income provides a key stimulus driver for growth in sectors such as retail. Investors are already responding confidently regarding a projected increase in spending. Major retailers such as JB Hi-Fi and Harvey Norman have seen significant positive gains in the share market, up 4.2 and 5.4 percent respectively. The biggest challenge currently faced however is whether there will be a possible delay to the tax reform. Whilst Morrison has promised that the tax cuts will be delivered during the next financial year, whether those changes will come into effect for FY 2019 becomes increasingly unlikely. As June 30 creeps closer, the Australian Tax Office is lobbying for parliament to change the law sooner or even retrospectively. Lowe has become increasingly critical of the government as the drivers that he predicts will grow the economy do not align well with the Coalition’s actions past and present. Whilst he does not want to give the government advice, he has called out the current tax system for failing to foster growth, something likely tough to muster for Treasurer Josh Frydenberg who has pledged 1.25 million new jobs within the next 5 years.
Monetary policy has historically had a more direct transmission effect on the economy due to it previously having more impact on the interest rate charged on variable home loans. A major transition away from this occured in 2015 when the Australian Prudential Regulation Authority required lenders to incorporate a serviceability buffer of 2 percent above a loan product rate and a minimum rate of 7 percent. When the banks created a serviceability floor rate of 7.25 percent, the customer’s borrowing capacity was effectively capped notwithstanding any changes to the cash rate. A steep decline in home lending saw APRA respond by undoing some of its changes to borrowing constraints. Reversing the serviceability buffer could allow a borrower’s capacity to increase by as much as 14 percent. A lower interest rate combined with more relaxed loan serviceability requirements could result in a 5-10 percent increase in Australian house prices. The stimulatory effect of these changes could be dramatic however higher property prices combined with stagnant incomes should be treated with caution.
By Guy Clarke
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