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So do rates fall next Tuesday? It's a very close call.

No inflation disaster news from the West's best economy!

Peter Switzer
28 July 2016

By Peter Switzer

Our latest inflation reading has come in and we’ve defied the doomsday merchants who have had the Aussie economy on a nosedive for too long.

They argued that the negative inflation reading in the March quarter was a prelude to sustained deflation here in Australia, but they were wrong.

Apart from having to find excuses for their low-ball forecasts for Aussie economic growth, which has now averaged 3.6% (if you annualize the past six months of growth, as the Reserve Bank does for an accurate snapshot), then they really look horribly hopeless when it comes to knowing our economy.

Mind you, inflation is low but it’s not deflation. The Consumer Price Index (CPI) – the main measure of inflation in Australia – rose by 0.4% in the June quarter, in line with expectations. The annual rate of inflation fell from 1.3% to 1%, equaling the low figure that was set in June 1999. So inflation stands at a 17-year low.

This happens because when working out annual inflation, four quarters of prices movements are put together. And as this June quarter comes into calculations, June 2015’s number, which was higher than this June, comes in and drives the inflation number down.

The importance of all this inflation talk is whether the Reserve Bank will cut the official cash rate next Tuesday. The call is 50-50 because this 0.4% number we saw yesterday was not another negative. The March quarter saw inflation go negative (which is deflation) but you needed to see at least two quarters before you believed it. And if this happened, there would have been a 100% support for a rate cut on Tuesday.

With a positive 0.4% rise in the June quarter, there are those who argue this: why not keep rates on hold because the economy is doing pretty well? They also say that if there is another financial problem worldwide that could bring in a recession, then having a Reserve Bank with more ammunition than most central banks in the world could be a nice piece of insurance.

There will be members on the board of the RBA who will be arguing this, so it will be a close call.

Our growth is better than nearly all western economies and we’ve been doing it without a recession for 25 years. And with inflation not deflation, the RBA has a tough meeting next Tuesday to decide whether they cut or not.

It’s why I put us forward as the best economy in the world and while we could be trumped by another economy on some grounds, on others we’d be a clear winner.

Making it harder, unemployment is at around two and a half year lows, we have positive official interest rates, not negative like many western economies, and our government to debt GDP is one of the lowest in the western world, so a rate cut could be held off until the RBA sees some more economic readings.

That said, chief economists think a cut is coming. CommSec’s Craig James says ‘yes’ and so does AMP’s Shane Oliver. Westpac’s Bill Evans tipped it a week ago.

I personally don’t think we need it because the economy is doing pretty well, but one more cut, which I’d like to see as the last, would help the stock market because low interest rates make dividend-paying stocks more attractive.

It also lowers the business cost of interest rates, which goes to the bottom line.

Lower rates also bring down the dollar, which helps a lot of businesses that employ people but it helps their stock prices as well.

And if the cut is sold well by the RBA, then it could be a plus for consumer and business confidence. It can’t be seen as a desperate central bank worried about Malcolm Turnbull’s mantra of jobs and growth. It really should have been “growth and jobs” because the former creates the latter, so growth is all-important and lower interest rates will help us grow faster.

Of course, those wanting to live off term deposits will hate what I’m writing but that safe game is over until we see our economy and the key economies of the world become normal again. By normal I mean an economy that is both growing jobs and inflation, which means interest rates have to sneak up to control future inflation. That’s when term deposit lovers will get what they want but great rates such as 4-5% unfortunately for them, are a long way off.

Interestingly, the current RBA Governor, Glenn Stevens retires on September 18 so he has two shots left in his locker. I reckon he’d only use one and he’s such a team player he could leave his successor, Phil Lowe, as much ammo as possible, in case he needs it.

That said, Glenn and the board might like to get that damn dollar down to the low 70US cents level to help the economy. The OK inflation number took the dollar up because smarties guessed that the expected rate cut on Tuesday might now be delayed, or permanently shelved! 

The five-day chart above shows how the dollar was sliding on the expectation that a rate cut looked certain but it spiked after the inflation reading.

I have economics training and I’d like to see one more cut but I’m not trained to guess what the RBA board will do on Tuesday. However, we economists are still asked to guess. I think they should but I can see why they might want to hold fire.

This is how my mate Shane Oliver sees it: “The June quarter inflation data is not low enough to make an RBA rate cut at next week’s meeting certain, particularly given that recent economic data has been reasonably good. However, on balance, we expect that the RBA will move again to help ensure that inflation expectations don’t become entrenched below 2% as has been the case in several other countries, so that there is reasonable confidence that inflation will move back into the target zone in a reasonable time frame and to head off a rebound in the $A that will likely follow if it doesn’t cut again.”

Shane’s punting on a cut and, like him, I think it will be a close run thing but there could be concerns that lower interest rates could increase the heat in the housing sector, which the RBA wanted to cool down as prices and apartment supply were getting to worrying levels.

For once, I’m sitting on the fence. I want a cut but the RBA could play it safe and watch company earnings season, which starts next month. If the economic and corporate picture gets a little gloomier, then maybe Glenn could go out on another cut.

That said, as I argued earlier, he might want to leave Phil plenty of ammo, especially if his successor has to deal with a Trump US presidency victory and a rattled global stock market scenario!

If you liked this article you'll love the Switzer Report, our newsletter and website for trustees of self-managed super funds. Click here for a FREE trial and to hear more of Peter’s expert commentary and advice.

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