Dr Brendan Rynne, KPMG Chief Economist, comments on today’s RBA meeting
I would suggest that the most prudent action from tomorrow’s Board meeting is for the RBA is to keep rates on hold – nevertheless, both domestic and international factors are increasingly biasing towards a further rate cut. And this could yet force a cut before Christmas, even with the risk that house prices in Sydney and Melbourne continue to experience a sharp v-shaped recovery.
When I look at the three key factors – underlying inflation, unemployment and exchange rates – there are more reasons to drop rates than there are to keeping them on hold. But time is still on our side at the moment, and that’s a good enough reason to sit tight tomorrow and see where some global uncertainties start to fall.
Underlying inflation, as measured by the trimmed mean CPI, remains weak at 1.6 percent year on year – the 15th consecutive quarter where this measure has been less than the 2 percent lower end of the RBA target range. A continuation in easing interest rates will, eventually, help put some price pressure back into the economy.
The unemployment rate remains sticky at low 5 percents, but the issue here hasn’t been so much a lack of employment growth reflecting a weakness in the labour market per se, but rather the opposite. The participation rate is at an all-time high, meaning more and more people are seeing strength in the labour market and want to join it.
The risk is that aggregate demand softens, reducing labour demand, and the unemployment rate starts to rise because there are fewer people actually working rather than more people looking for work than there has been before. A continuation in easing interest rates will, eventually, help drive investment activity – maybe proportionally less than when the economy is stronger, but growth nonetheless – and this will put some labour market pressure back into the economy.
Our exchange rate has done a lot of the heavy lifting in keeping the nation growing over the past year, even despite the trade tensions and global economic headwinds. With other central banks now starting an easing cycle our currency will lose some of its competitive punch – we’ve seen this in the last week with the US Federal Reserve cutting its funds rate, and the AUD appreciating nearly 1 cent over the past 5 days.
To the extent our domestic economy remains weak due to soft consumption and investment, relying on export demand to keep our workforce employed and businesses profitable means we need to keep our currency globally competitive. So here too, a continuation in easing interest rates will keep export demand high.
There is one fundamental reason to keep rates on hold however – house prices. We have already seen the house prices losses that have occurred in Sydney and Melbourne over the past 18 months have now been nearly fully recovered, and further interest rate cuts are likely to help fuel further price rises.
But, as KPMG analysis has shown before, interest rates are only one factor that drives house prices, with supply just as important. As house prices rise, and the cost of financing falls for new developments, supply will also start to rise again.
The RBA has to consider therefore the trade-off between dropping the cash rate and realising short term house price growth (until new supply kicks in to stabilise prices) and keeping the cash rate on hold and potentially losing some export demand but quelling some of the heat in the Sydney and Melbourne housing markets.
So, while there is not the burning platform right now to see rates drop down another notch, I believe that on balance there’s the likelihood they’ll drop again and possibly before the end of the year.
Ultimately cutting cash rates might help short term cyclical adjustments, but KPMG remains of the view that Australia needs a comprehensive agenda of fiscal policy measures targeted at the short-medium term, allied to productivity reforms and tax reforms rebalancing tax receipts away from Corporate and Personal Income taxes and towards a higher consumption tax mix.