Chief economist update: RBA more likely to cut

The Reserve Bank of Australia (RBA) painted an optimistic picture of the global and domestic economies when it held its policy meeting last month (6 November) before concluding that "...the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time."

The RBA kept the official interest rate unchanged at 1.5% that time - as it had in each of its previous monthly meetings since it dropped them by 25 basis points way back in August 2016.

Financial markets expect the December RBA tete-a-tete to result in more of the same - steady interest rates.

This is because the RBA will find that although global growth is continuing - and the latest US-China trade war got a stay of execution over the weekend (Trump will hold off from raising the 10% tariff on Chinese exports to 25% on 1 January 2019, provided a comprehensive deal is reached within 90 days) - the growth momentum is slowing.

China's official manufacturing PMI declined to a reading of 50 in November from 50.2 in the previous month - indicating that the economy has reached the point of stagnation.

Japan's economy contracted by 0.3% in the third quarter (from 0.8% in the second); the Eurozone's GDP growth halved to just 0.2% in the September quarter (from 0.4%); and the UK's growth remains uncertain due to Brexit.

The indications from the domestic economy haven't changed much from the last meeting. The labour market is improving - the unemployment rate is at 5% - but inflation has softened (headline down to 1.9% in the September quarter (from 2.1) - the sharp decline in oil prices and slight increase in the Australian dollar would further damp inflation pressures going forward.

In its November statement, the RBA printed that: "Business conditions are positive and non-mining business investment is expected to increase." The latest capex spending plans proved the RBA's expectations to be true. As per the ABS, "This is 4.4% higher than Estimate 4 for 2017-18. Estimate 4 is 11.3% higher than Estimate 3 for 2018-19."

Still, the RBA's also correct in printing that: "One continuing source of uncertainty is the outlook for household consumption. Growth in household income remains low, debt levels are high and some asset prices have declined."

"Growth in household income low." While wages increased by 2.3% in the year to the September quarter (from 2.1% in the second) - this represents just half of the 4% average growth rate during the boom years preceding the 2008 global financial crisis.

"Debt levels are high". Household debt to disposable income rose to an all-time high of 190.5% in the second quarter (latest available).

"And some asset prices have declined". The S&P/ASX 200 index has declined by 4% in the year to November. CoreLogic's "5 city capital aggregate" home value index fell by 5.7% in the year to November, led by 8.1% drop in Sydney and a 5.8% decline in Melbourne. It has a negative wealth effect.

To these could be added the persistent decline in personal credit - down 1.6% in the year to October from 1.5% in the previous month. Personal credit had consistently decreased over the past 34 months.

While the RBA has explicitly stated that the next move in rates would likely be up rather than down and financial markets are betting on the same (whenever that may be), the mounting challenges to the global and domestic economies are pointing in the opposite direction.

The history of the RBA's policy movements also leans towards a cut rather than a lift (whenever that may be). The second longest stretch of steady interest rates is the 18-month period between August 2013 and January 2015 with the cash rate frozen at 2.5% before being lowered to 2.25% on February 2015.

'Twas the same when the RBA held interest rates unchanged at 2% between May 2015 and April 2016 or at 4.75% back in November 2010 to October 2011, both were followed by a reduction in interest rates.

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