RBA to Cut Interest Rates to 1% by Year’s End?

With financial markets continuing to price in the possibility of an RBA interest rate cut by the end of this year, it’s worth examining the factors that could lead to this move.

The most important factor is the housing market, which has taken a series of blows over the past six months.

Other correlated factors include retail sales, business conditions, and job ads.

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Housing market the main drag, retail sales suffer, job ads also down

Despite the recent iron ore rally, the housing market downturn could create a negative wealth effect.

A wealth effect is a largely psychological phenomenon where rising/falling asset values impact consumer spending behaviour.

The latest data we have on the housing market is building approvals which are down sharply:

RBA Interest Rate

Source: ABS

Fears of the negative wealth effect occurring are starting to manifest themselves in retail sales data.

As per the Australian Bureau of Statistics latest data, retail sales volumes rose by just 0.1%, missing estimates of 0.5%.

Business conditions are also suffering.

The NAB Business survey shows that business conditions have declined at a velocity not seen since the GFC:

RBA Interest Rate

Source: NAB

As per the ANZ Job Advertisements data, the number of advertisements fell 1.7% month-over-month in January this year.

As a result, you can see the contours of the momentum feedback loop form: declining housing values impact consumer spending, which in turn affects business conditions, which subsequently shows up in job ads. This then impacts the labour market.

ANZ’s head of Australian Economics David Plank says that:

It is not surprising that this loss of momentum is translating into weaker job ads. This should show up in actual hiring in due course, though employment does lag other parts of the economy.

Your house loses value, you spend less, the business environment worsens, they need less hands in the shop, less job ads go out and less hires make into the workforce. Rinse and repeat.

What does this mean for the RBA interest rate going forward?

Let’s look at what the RBA Governor Phillip Lowe said most recently:

Looking forward, there are scenarios where the next move in the cash rate is up and other scenarios where it is down. Over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced.

This is a change in stance, previously the noises out of the RBA were thoroughly hawkish, i.e. in favour of rate hikes.

But remember, the main task of central banks is to maintain as close to full employment of the population as possible (for better or worse).

Going back to the momentum feedback loop, it appears the only direction for rates can be down.

The RBA is watching the labour market closely, and if this is the case they must surely see the writing on the wall.

And it all comes back to the housing market.

That is why AMP Capital’s Shane Oliver is quoted by Business Insider as saying:

Our view is that RBA is underestimating the impact of the housing downturn on the economy — both directly via reduced housing construction and also indirectly via reduced consumer spending — and as a consequence we see weaker growth and lower inflation than the RBA is forecasting … as a result our view remains that the RBA will cut the cash rate to 1% by year end.

I’m tempted to agree with Mr Oliver.

Mid-year, a 25 basis point cut could be on the cards (maybe sooner if the US–China trade deal is scrapped). As growth slows during this period, pressure may build for another 25 basis point cut in the October–December range.

But maybe all this is bearish doom-mongering.

Put it this way, I hope I’m wrong.

Regards,

Lachlann Tierney,
For Money Morning

PS: If interest rates get cut, people may flee to gold. Learn how to invest in gold in 2019 with our free report which is available here.


Lachlann Tierney is a writer for Money Morning and has been investing for nearly a decade. With an MSc from the London School of Economics, he brings a sound understanding of global markets to his writing. Lachlann is interested in emerging technologies, energy solutions and helping people invest their money wisely. Recently, he has been working with Phil Anderson and Terence Duffy. They have three publications:

Phil Anderson’s Time Trader
Cycles, Trends & Forecasts
Money Morning Trader


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