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Australia's high levels of household debt combined with slow wages growth means there are an increasing number of families who have little cash flow for discretionary spending.
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Will the cash rate budge in 2018?

With its considerable direct and trickle-down effects on the Australian economy, particularly interest rates and inflation, it’s no wonder The Reserve Bank of Australia’s official cash rate decision on 6 February was much debated and anticipated.

At its first Board meeting for the year, the Reserve Bank of Australia (RBA) announced it would keep the official cash rate on hold at its record low.

The official cash rate set by the RBA is the interest rate that commercial banks charge each other on overnight loans and influences the term structure of interest rates in the economy, including mortgage interest rates, as well as the behaviour of borrowers and lenders, general economic activity, and generally the rate of inflation.

In his statement following the Board’s decision, RBA Governor Philip Lowe forecast GDP growth to increase, and described business conditions as ‘positive’ and the outlook for non-mining business investment as ‘improved’. In addition, he noted that public infrastructure investment is contributing to supporting the economy, household debt levels are high and wages growth is low.

The official cash rate has been at a record low since August 2016, when the RBA decided to drop 0.25 per cent to improve prospects for sustainable economic growth and inflation returning to target over time. The February 2018 decision to maintain the official cash rate reflects RBA’s ongoing hopes to achieve similar outcomes.

For Adam Boyton, Chief Economist at Deutsche Bank, the key paragraph in Lowe’s statement is: ‘The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected although this progress is likely to be gradual’. The key word being ‘gradual’.

 

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Controlling inflation preserves the value of money and encourages strong, sustainable economic growth.

Discussions on whether the official cash rate will change are popular among many of Australia’s leading economists, financial advisers and business owners

As Australia’s central bank, the RBA issues currency and conducts the nation’s monetary policy with the duty to maintain price stability, full employment and the economic prosperity and welfare of the Australian people. To achieve this, the RBA has an inflation target and endeavours to keep consumer price inflation to between two and three per cent over the medium term. Controlling inflation preserves the value of money and encourages strong, sustainable economic growth.

The recent decision to hold the official cash rate wasn’t a surprise to the 23 economists recently surveyed by Bloomberg who forecast the rate would remain on hold in February. In the lead-up to each RBA monetary policy meeting, discussions on whether the official cash rate will change are popular among many of Australia’s leading economists, financial advisers and business owners.

According to George Tharenou, Australian Economist at UBS, UBS expected the RBA to hold a ‘neutral’ stance and maintain the current official cash rate until 2019.

“While GDP is picking up, Lowe’s comments suggest the RBA is unlikely to hike pre-emptively unless inflation rises. Looking ahead, UBS still expect the RBA to keep the cash rate on hold until 2019, despite our modestly more positive growth outlook, given we think the RBA will wait for inflation to follow growth before hiking,” says Tharenou.

AMP Senior Economist Diana Mousina, however, told financial comparison site Canstar recently she believes there will not be a change from the RBA until the end of the year, at a 0.25 per cent increase, and that the bank doesn’t want to move too quickly on raising interest rates.

 

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The RBA’s decision to keep the cash rate low will help encourage companies to grow and hire.

How a low official cash rate can gradually improve low wages growth and reduce household debt

Lowering the official cash rate generally boosts the economy and inflation by encouraging borrowing which, over time, leads to increased spending and business investment. Alternately, raising the rate usually slows demand and the rate of inflation, as higher interest rates generally restrain lending growth.

“When the RBA raises the cash rate, generally it is because they want to put the brakes on demand growth and the rate of inflation. Higher interest rates tend to act as a restraint on lending growth, which has a negative impact on demand and inflation,” says Gareth Aird, senior economist at Commonwealth Bank.

While Lowe states that ‘business conditions are positive’ with strong growth in employment in 2017, there is ongoing slow wages growth. Although interest rates are low, minor or no wage increases makes it more challenging for anyone servicing a loan, including a mortgage – particularly with the current high household debt.

“Notwithstanding the improving labour market, wage growth remains low… although the strong economy should see some lift in wage growth over time. There are reports that some employers are finding it more difficult to hire workers with the necessary skills,” says Lowe. This demand, many are hoping, may eventually translate into higher wages for those with in-demand skills.

Bloomberg’s Michael Heath believes wage growth will remain a distant prospect, but the positive is that the RBA’s decision to keep the cash rate low will help encourage companies to grow and hire.

Steve Mickenbecker, Group Executive of Financial Service at Canstar, is concerned about the persisting low wage growth. “Of particular worry is that wages growth has been below 2 per cent for 18 months. We have a record 3.3 per cent jobs growth figure for the past year, and wages should be growing, but they still don’t,” says Mickenbecker.

“Rapid population growth and a jump in workforce participation has prevented the hiring boom from cutting deeply into the jobless rate and sparking wage gains and inflation. The Reserve Bank of Australia has opted to be a steadying influence on the economy, keeping rates at a record-low for 18 months to encourage firms to expand and take on new employees, a strategy that’s paying some dividends,” says Heath.

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Jane Ryder

Jane Ryder is a writer and PR and marketing consultant who brings over 25 years’ experience creating content and promotional strategies for clients big and small. Motivated by a love of music, design, food, wine and travel, her career to date includes writing, producing and styling for some of Australia’s leading fashion and lifestyle magazines, promoting artists at record company Sony Music, and running her own consultancy. When not at her desk, Jane spends far too much time coaxing Bailey her cavoodle to get off the couch and her teens do their chores and far too little of it swimming, reading and enjoying long lunches with friends.

The opinions expressed in this article are the opinions of the author(s) and not necessarily those of Homeloans Ltd.