- Reports about the demise of the Australian economy are greatly exaggerated.
- We are witnessing a number of push and pull forces at work on the local economy, but we are yet to see a sharp or sustained downturn in actual activity.
- In spite of widespread uncertainty and market volatility, the Australian economic outlook as a whole is not seriously at risk and we may be witnessing a return to a ‘Goldilocks’ outlook.
- Australia is one of the few countries with the ability to swiftly deploy monetary and fiscal measures to avoid a downfall.
Following the October Reserve Bank Board meeting, the RBA issued its customary press release, but with less than the customary amount of clarity. So while a few read this statement as the glass is half-full, many more took it to mean the glass is half-empty.
Governor Glenn Stevens observed: “While there remain good reasons to expect solid growth over the medium term, the indications are that the pace of near-term growth is unlikely to be as strong as earlier expected."
Like the IMF, the RBA expects global and local economic activity to be slower than previously forecast. There is a subtle but important distinction here – ‘slower than expected’ does not mean the same as ‘slow’, and both still anticipate moderate short-term growth in Australia returning to around 3.5 – 4.0% over the course of the financial year.
One could be forgiven for thinking that our central bankers are being deliberately ambiguous, but their somewhat cloudy message is most likely a reflection of the patchwork nature of our local economy – and the correspondingly varied perspectives of various Board members. We are constantly witnessing a number of push and pull forces at work on the local economy, with mining and related sectors steaming ahead, while others drag their heels as cautious consumers and the currency have restrained activity. Unemployment has nudged up, but labour markets remain tight. In addition, consumer confidence has rebounded,while building and retail data also show month-to month volatility.
So while many in the market believe the year ahead will be a tough one for Australia, with nominal and real cash rates set to fall, the RBA appears less certain about how the next 12 months or so will pan out. Yes, there is considerable volatility and pessimism in the face of concerns over European debt and how this will be resolved, but we are yet to see these translate into an actual downturn, and fortunately central banks – unlike financial markets – act on fact rather than fear.
Regardless of the uncertainty, the Australian economic outlook as a whole is not seriously at risk. In his statement, the Governor’s quiet nod to the recent sharp drop in the Aussie dollar should not be ignored as it acknowledges the substantial weakening in the currency is a de facto easing in itself.
Indeed, what the RBA seems to be suggesting is a return to a ‘Goldilocks’ outlook with moderate economic growth accompanied by well-behaved inflation. So while rate rises appear to be off the agenda for the time being, so too are rate cuts.
While the current economic outlook remains unclear, short-dated futures are pricing in at least two rate cuts over the remainder of the financial year. Interestingly, futures are showing a pretty quick turnaround in these cuts. Surely, if the RBA really sees a softer economy lasting only until the middle of next year, it is implausible that we would see cuts in the run up to Christmas followed by hikes six months later. We’ll only see the RBA step in if the outlook turns out to be as bad as the pessimists are saying, and a prolonged global downturn that includes China and Australia becomes a reality.
So the next big questions must be: What if the global economy does slow substantially more than officials (including the RBA and IMF) currently expect? How far would and could the RBA go? And would fiscal policy be called on to help?
On the monetary policy front, Australia is one of the few economies – either advanced or developing – with the capacity to cut short term interest rates.
The following chart shows that both nominal and real rates are far from tight but there is room for the RBA Board to move, in the words of the Governor “should that prove necessary”.
Monetary policy is not the only weapon in Australia’s arsenal against a downturn in growth.
Fiscal policy is also a force and we saw in the immediate wake of the global financial crisis how effective it can be when policy is timely, targeted and temporary.
Paradoxically, Australia stands as one of the countries most able, but least likely, to require additional fiscal stimulus in the coming year. Australia is sharply focused on returning its budget position into the black as soon as possible. However, unlike Greece which has an urgent need to do so with debt to GDP ratio of 160%, Australia’s net debt is only 25% of GDP, which gives policy makers plenty of room to move should the need arise.
The RBA appears to be marking time on interest rates and will be watching the data with a particularly close eye in the run-up to Christmas for any signs of faltering. In the event that such signs appear, both monetary and fiscal policy can be swiftly and successfully brought to bear.
Reports of the demise of the Australian economy appear greatly exaggerated.