Shane Oliver, Head of Investment Strategy& Chief Economist
RBA has more to do - howlow will the cash rate go?
EDITION 33 – 4 OCTOBER 2012
>The need to boost the non-mining sectors of theeconomy as the mining boom fades at a time when the$A remains strong and fiscal cutbacks are intensifyingmeans the RBA will have to cut interest rates further.>Post GFC caution has likely resulted in a reduction in theneutral level for bank lending rates, such that they areonly just now starting to become stimulatory.>Our assessment remains that standard variablemortgage rates will need to fall to around 6%, whichimplies that the official cash rate will need to fall to 2.5%.We expect this to occur over the next six months, withthe RBA cutting again next month by another 0.25%.>Bank deposit rates will fall further, but the Australianshare market is likely to be a key beneficiary as lower interest rates eventually boost housing activity & retailing.
The Australian economic outlook has clearly deteriorated.Recognising this, the RBA has resumed interest rate cuts.Our assessment remains that the RBA has more work to do.But how low will rates go? What does it mean for investors?
The growth outlook
While economic growth in Australia has been reasonable of late, eg 3.7% over the year to the June quarter, and wellabove that in comparable countries, our assessment is thatstorm clouds are brewing and that growth will slow to around2.5% over the year ahead, which is well below trend growthof around 3-3.25%. The basic issue is that the mining boomis losing momentum at a time when the non-mining part of the economy is weak and fiscal austerity is intensifying:
Mining investment looks like it will peak next year. For thefirst time in years the June quarter survey of mininginvestment intentions did not show an upgrade in plansfor the current financial year and projects under consideration have peaked. Falling mining sector profitssuggests mining projects remain at risk. Investmentoutside the mining sector remains weak. This all points toa sharp slowing in business investment in 2013-14.
-20%-10%0%10%20%30%40%90929496980002040608101214EstimatesBusiness investment,fin yr, % changePeak in mining investment to lead to a sharpslowing in business investment in 2013-14
Source: Thomson Reuters, AMP Capital
At the same time, a sharp fall in Australia’s terms of tradeis leading to a loss of national income which will alsoslow spending and growth. Stronger mining exports, iestage 3 of the mining boom, will provide a boost togrowth but this may not become evident until around2014-15.
506070809010011012013014000010203040506070809101112-302070120170Australia's termsof trade (LHS)Iron ore price, $US/tonne (RHS)
(Contract prices pre 2009 then spot)
Iron ore price slump points to a further terms of trade fall
Source: Bloomberg, AMP Capital
This is all occurring at a time when non-mining indicatorsfor the economy remain soft. Consumer and businessconfidence are sub-par, despite being almost a year intoan interest rate cutting cycle.
Retail sales remain subdued, with Government handoutsproviding a brief boost in May and June, only to seesoftness return again. Annual retail sales growth is stuckin a range around 3%. With confidence remaining sub-par, job insecurity running high and interest rates still toohigh its hard to see a strong pick up yet. Ongoingconsumer caution in terms of attitudes towards debt andspending is highlighted by the next chart showing a muchhigher proportion Australians compared to the pre GFCperiod continuing to nominate paying down debt as thewisest place for savings.
% of Australian's nominatingpaying down debt as thewisest place for savingsA higher proportion of Australians' are focussed onpaying down debtPre crisis averageNew norm
Source: Westpac/Melbourne Institute, AMP Capital
While housing related indicators have probably bottomedon average, taken separately they present a very mixedpicture with house prices up over the past few months,housing finance, housing credit and building approvalslooking like they have bottomed but remaining soft andnew home sales still falling. The fact that there has onlybeen such a tentative response to lower mortgage ratesindicates that mortgage rates have not fallen enough.