Rates to Stay Put

THE RESERVE BANK of Australia recently indicated it had concluded global economic risks had diminished and the Bank was therefore comfortable leaving the official cash rate where it was – and it’s quite probable the rate will stay that way for a month or two.

 At present, interest rates are neither causing the economy to accelerate or to decelerate. That said, I still expect that at some point the Reserve Bank will need to cut rates again because even though the global economic backdrop has become less risky, there are still some risks with respect to Europe. More importantly, however, the domestic situation appears to have weakened somewhat.

The housing sector has not really experienced a recovery, despite the two cash rate cuts of late last year.

Consumer confidence has fallen back to the level it was at prior to the rate cuts. Business confidence is still struggling. Retail is still very weak, and anecdotes regarding the labour market suggest it is quite soft, with more layoffs being announced, which is likely to result in rising unemployment.

International worries have become, if you like, less worrying and the risk in Europe seems to be of a recession rather than a complete meltdown.

Domestic issues, however, have become more of a concern.

In the meantime, data coming out of the United States have been quite solid and there is greater confidence that China will continue to grow at a reasonable pace. In Australia, by contrast, we have continued to see very weak economic readings and heard depressing anecdotes of layoffs and a rise in the number of unsold homes.

The domestic issues are perhaps less pressing because, while they are literally closer to home, it’s not as though the economy is in turmoil. There is no need to act with great urgency.

 Reserve Bank Deputy Governor Phillip Lowe has said that if unemployment were to rise, it would suggest the negative impact of the strong Australian dollar on the economy would outweigh the positive impact of the mining boom and therefore there might be a case to ease.

So, unemployment seems to be the key indicator that analysts are looking for in terms of a rate cut.

In terms of housing, I think what the Reserve Bank wants is an extended period of house price inactivity where house prices really just track sideways. They don’t want a renewed surge in house prices, but they don’t want a collapse in house prices either.

The reason they don’t want a surge is that they probably still think Australians have too much debt, and a renewed surge would only result in more debt and perhaps renewed concerns about a housing bubble.

By the same token, they don’t want a house price crash because they know the damage that can cause to the economy.

So, what I really think the Reserve Bank would like to engineer is a lengthy period in which house prices trend sideways to enable rents and income levels to catch up and to bring down measures of overvaluation in the housing market.