Economics
Chief economist update: Cash rate should be 1%

The Australian economy has slowed - big time.

The Australian Bureau of Statistics' (ABS) National Accounts report showed that GDP grew by a mere 0.2% in the December 2018 quarter from 0.3% in the previous three-month period, taking the annual growth rate down to 2.3% in the year to the fourth quarter from 2.7%.

The details show that only three components contributed to fourth quarter GDP growth: government consumption (0.3 percentage points); household consumption (0.2 pps) and, inventories (0.2 pps).

But government consumption could not continue to provide such strong contribution going forward without negatively impacting the Budget. Just have a read at what the ABS said about this:

"Government final consumption expenditure rose 1.8% in the December quarter 2018 and remains strong through the year at 5.6%. National non-defence (4.2%) was the main contributor to growth in the quarter, due to increases in social benefits to households from continued government spending on disability, health and aged care services.

"State and local government expenditure increased 1.1% driven by rises in non-employee expenses," it said.

The contribution from inventories last quarter is an ominous sign for the next quarter - more so given the slowing in household consumption because it indicates that the December quarter's increase in inventories is unwanted.

Household consumption growth eased to 2% in the year to the December quarter from 2.5% in September and 2.9% in June. Stagnant wages growth, declining disposable income - down to 2% in the year to the Q4 - the fifth straight quarter of decline - from 2.7% in Q3 don't offer good tidings for the outlook on household consumption.

There's also the negative wealth effect from falling property prices.

Yet, RBA governor Philip Lowe doesn't seem perturbed. Lowe told his audience at the AFR Business Summit yesterday that "the "wealth effect" on consumer spending from falling house prices will be limited to cars and furniture" that is "unlikely to derail our economic expansion..."

No Philip. The property market's large multiplier effect on the economy will certainly not limit the retrenchment in consumption to "cars and furnitures."

The HIA Economics Group published a report revealing that, "The total multiplier for output and employment in the construction industry is estimated by the ABS to be 2.866. So, for every $1 million increase in construction output, there is an increase in output elsewhere in the economy of $2.9 million."

RBA rate cut here we come. According to the AFR, "Ten forecasters challenge the RBA's neutral monetary policy bias", with all now expecting one (or two) 25 basis point rate cuts this year.

They've now come around to Financial Standard's view published way back in June 2018.

While they've provided ratioanales for their change of heart, Financial Standard had always relied on that time tested work by John Taylor to estimate the required level of interest rate for a given state of the economy.

Plugging in growth and inflation, Australia's "Taylor Rule" measure says, that the official cash rates should be at 1.0%.

The two rate cuts camp has it!

New York Fed President John Williams revealed that the current fed funds rate, "puts us right at neutral."

The same thing Financial Standard published a week earlier, The Fed has hit neutral. Thanks to the Taylor Rule.

Read more: ABSFinancial StandardTaylor RuleAustralian Bureau of StatisticsJohn TaylorNational AccountsPhilip Lowe
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