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Real world economists think cut rates, while unreal world economists — my old academic buddies — say don’t bet on it.

Unfortunately we might need another interest rate cut!

Peter Switzer
1 August 2016

By Peter Switzer

Tuesday is another interest rate decision day for the Reserve Bank and the betting on whether we see another rate cut here has been 50:50. 

Given the latest economic growth reading in the US, however, I think another cut there is a damn good chance. Whether we need another one here is debatable because current economic readings are pretty damn good but the RBA Board has to look forward and try to guess our economic future and set rates accordingly.

I feel for retirees, who are aghast at how low term deposit rates have gone. These retirees are those who love the safety of government-backed term deposits and generally feel OK if they’re getting 5% or more. As the rates have fallen to the 2% plus region, it really has put the pinch on their lifestyle.

Unfortunately for them, the RBA is mindful of the impact of current interest rate policy but it does place a higher priority on creating economic growth and more jobs nowadays. If they can get the economy growing at the current levels or even faster, then rising rather than falling inflation will be the big issue and that’s when interest rates — term deposit, loan and the cash rate — will start rising again.

Like all central banks, the RBA wants to get our economy back to normal, so a rate cut now might stop a few more later.

Anyone privy to my presentation in Bega on Friday, where they held their regional Economic Summit, heard me say our economy is doing well, with economic growth over 3% (the fastest for three and a half years), the unemployment rate is at 5.8% (which is around two and a half year lows), house prices are doing well in most states, business confidence and conditions are above their long-term average and consumer confidence is up 8% for the year.

That’s a pretty good report card, so why do the chief economists, Bill Evans of Westpac, Shane Oliver of AMP Capital and James Craig of CommSec all expect a rate cut tomorrow?

I think a big reason will be something these three guys didn’t know when they were surveyed last week and that’s the worse than expected economic growth rate in the US.

Just when a lot of economists were expecting a 2.5% number, the first official guess at the result was only 1.2%! The cause wasn’t a scared consumer because Yanks are shopping but not dropping (bless their little wallets), but it was tightwad businesses that are not investing.

This means the Fed won’t raise interest rates any time soon. Our dollar kicks off trading today at 75.95 US cents and could even go higher. This hurts our competitiveness, growth and job creation, so the RBA could easily say ‘yes’ to another cut tomorrow.

On top of that, our latest reading on inflation was only 1% and while it rose in the most recent quarter by 0.4%, which was better than the small fall in the March quarter, the current annual rate is at a 17-year low!

Meanwhile, a lot economic data is still looking good but a bit of softening is happening so a rate cut could be timely. On Friday we saw overall lending rise but as CommSec headlined it — it was “softening” and business lending actually fell.

This is how Craig James assessed the data and how it could impact on the RBA and their rate cut decision tomorrow:

“The Reserve Bank Board can feel comfortable in cutting rates next Tuesday. The headline consumer price index showed annual growth at 17-year lows, underlying inflation is at record lows, imported consumer prices have fallen the most in four years and annual business inflation is standing at just 1.0 per cent. The weak lending data removes yet another barrier to the Reserve Bank cutting rates. We can’t read too much into the result as Brexit and the Federal Election may have influenced lending intentions. But a fall in both personal and business lending is not a good look – especially with interest rates already so low. It was the smallest monthly lift in credit in 33 months. It was the biggest annual fall in personal loans in almost four years. And it was the biggest monthly fall in business loans in 3½ years.”

The main concern for the RBA about a rate cut could be the impact on house prices and that could prove to be a sticking point. They might also like the idea of having 1.75% of cash rates up their sleeve, if another financial shock like the GFC comes along.

By the way, a mob called the ‘shadow board’, which tries to guess what the RBA board should decide, thinks there is an 18% chance of a rate cut. This board is made up of academic economists, including the ex-RBA board member Warwick McKibbin.

So real world economists think cut rates while unreal world economists — my old academic buddies — say don’t bet on it.

I think it is a 50:50 chance but my strongest case for a cut was the weak US growth number and what that could do to our dollar.

Our economy is doing well enough to go OK without a rate cut but another one tomorrow could be ‘a cut in time to save nine’. And if we saw nine cuts, the official cash rate would be minus 0.5% and none of us want to think about that!

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