Australia hovers on the brink of its first official interest rate rise in seven years if commentator consensus is anything to go by. Despite the RBA leaving interest rates at their historic low of 1.5% and having held firm for 20 consecutive months (a record), recent comments from the RBA Governor Philip Lowe have failed to dampen expectations of an interest rate rise, even in 2019.
The RBA has flagged that the easing cycle is finished and but there is no urgency for rates to increase. From the RBA perspective the reason for caution is mainly because the cyclical conditions appear better, but the structural conditions remain at least a little uncertain.
In a speech to the Australia-Israel Chamber of Commerce in Perth, Governor Lowe pointed out that cyclically “…the good news is that conditions have improved across most of Australia over the past year.” That good news includes 3.5% more people in jobs, with a steady unemployment rate and marginally improved participation rate.
Lowe also pointed out that non-mining investment was up 12.5%, with the trend expected to continue. That fed into improved business conditions survey outcomes. On the fourth of his cyclical upside themes, Lowe commented that:
“The fourth theme has been slow growth in wages. Wage increases around 2 per cent have become the norm in many parts of the country. This is in contrast to the 3 to 4 per cent increases that were the norm for most of the past two decades.”
Governor Lowe considers that the conditions in the economy are therefore generally good. However, he is an economist, so there is a ‘but’, and it is a big but.
Although he was pleased to advise that wages were finally beginning to grow across the economy and nation, the Governor was concerned by structural considerations, including the slow wages growth profile.
Governor Lowe made a lot of the dispersion and diffusion of employment and unemployment across Australia, especially in terms of its role in supporting the gradual equalization of the Australian economy. Work of the RBA shows that “…on average, regions are becoming more similar.” The chart below provides the examples.
So here is the BUT moment.
Governor Lowe then proceeded to explain that despite growing regional economic similarity, there are different average wage levels across the country, calculated from tax returns as the chart below shows.
The chart only shows the obvious differences between capital cities and regions, on average. But he assured his audience that the differences within regions are also significant.
Though he did not say so directly, Governor Lowe’s comments on interest rates were clearly pitched toward the national perspective. He said:
“In setting the national rate, I can assure you we pay close attention to what is happening right across the country.”
Thinking the interest rate forward, the RBA expects the economy to continue to ‘pick-up’, with wages growth and some inflation growth likely outputs.
Working against interest rate rises are international tensions on trade and the Chinese economies’ capabilities at managing financial system risks.
Growth in wages and lower unemployment are expected to occur only gradually, an important point, because the RBA is concerned that “…an increase will come as a shock to some people.”
Households in particular are expected to be placed under pressure by higher interest rates, mainly because net household indebtedness. Su-Lin Tan quoted Moody’s Investor Services in the Australian Financial Review on 13th April, recording that:
“Household debt as a proportion of disposable income was 188 per cent in September 2017 compared with 161 per cent in September 2012.”
Those levels of household debt have been built during this period of unprecedented low interest rates. Any interest rate rise will therefore be a shock to the system for many.
And for those reasons, despite the improvements in the economy, it is sufficiently gradual for Lowe to state that “…the Reserve Bank Board does not see a strong case for a near-term adjustment in monetary policy.”
Little wonder that many economists expect to see no rise in the cash rate until at least 2020. Indeed, the ABC’s Business Editor, Ian Verrender has commented that the RBA could well be forced to shove interest rates down further to stimulate the economy, but that global financial pressures are mounting.
